Fitch Rates Elmhurst Memorial Healthcare (IL) Series 2013 Revs 'BBB'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned a 'BBB' rating to the following revenue refunding bonds expected to be issued on behalf of Elmhurst Memorial Healthcare (EMH):

-- $76 million Illinois Finance Authority, series 2013A;

-- $50 million Illinois Finance Authority, series 2013B.

In addition, Fitch affirms the 'BBB' rating on the following revenue bonds issued on behalf of EMH:

--$124.1 million Illinois Health Facilities Authority, series 2002D;

--$124.8 million Illinois Finance Authority, series 2008A;

--$250 million Illinois Finance Authority variable-rate demand revenue bonds, series 2008B-E (*).

*Underlying Ratings. The series 2008B bonds are supported by a letter of credit (LOC) from JPMorgan Chase; the series 2008C bonds are supported by an LOC from RBS; the series 2008D bonds are supported by an LOC from the Northern Trust; and the series 2008E are supported by an LOC from Fifth Third Bank, N.A.

The series 2013A bonds are expected to be issued as 3-5-year taxable fixed-rate bonds while the series 2013B bonds are expected to be issued in floating-rate mode (R-Floats). Proceeds, together with other available funds, will be used to refund the outstanding series 2002 bonds, and pay certain costs of issuance. The series 2013A & B bonds are expected to price the week of October 24 through negotiation.

The Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group.

KEY RATING DRIVERS

BENEFIT OF MERGER WITH EDWARD: On July 1, 2013, Elmhurst Memorial Healthcare (EMH) and Edward Hospital and Health (Edward) finalized their merger. The new parent organization, Edward-Elmhurst Healthcare (EEH), is the sole corporate member of both institutions and holds reserved powers and the management team is primarily from Edward. Fitch believes the merger will benefit both organizations strategically over the long term and improve EMH's financial performance over the near term. Despite a weak financial profile, the assignment and affirmation of the 'BBB' rating reflects Fitch's expectation that the merger will result in improved profitability in 2014 and beyond as EMH realizes cost/expense efficiencies through consolidation of various shared services and supply chain and better clinical and physician resource allocation. The debt for each organization remains separately obligated at this time (Fitch does not rate Edward's debt).

CONTINUED WEAK FINANCIAL PROFILE: EMH's overall financial profile is weak and has been stressed for some time as the benefits from its significant investment in a new and expanded facility has been slow to be realized. Patient volumes continue to lag expectations. The majority of EMH's ratios compare unfavorably to Fitch's 'BBB' category medians.

IMPROVEMENT IN PERFORMANCE EXPECTED: With the merger and access to additional physician relationships, Fitch expects EMH's financial performance to improve over time. Fitch believes one of the largest opportunities with the merger is Edward's affiliation with DuPage Medical Group (DMG), a multispecialty group of over 400 physicians.

CAPITAL STRUCTURE REMAINS RISKY: EMH's debt structure is aggressive for its rating level with less than 1x cash to putable debt. Total LOC exposure is $256.5 million and they all expire in April 2014. Post financing, EMH's debt mix is 61% variable-rate debt and 39% fixed-rate. In addition, EMH has interest rate swap exposure that has had collateral posting requirements.

RATING SENSITIVITIES

FINANCIAL TURNAROUND EXPECTED: Given EMH's current weak financial profile, the inability for the new merger to result in a financial turnaround will likely lead to negative rating action. The management team is focusing on expense management and growing patient volumes and has budgeted an improvement to operating EBITDA margin in fiscal 2014; Fitch expects EMH to meet or exceed its 2014 budget.

CREDIT PROFILE

EEH, which includes Edward, is located in Naperville, IL, approximately 30 miles west from downtown Chicago and had $593 million in total revenue in fiscal 2013 (June 30 year-end), while EMH, located in Elmhurst, IL, approximately 17 miles west from downtown Chicago, had $394.5 million in total revenue in fiscal 2013 (June 30 year-end). The system has 676 beds across three hospitals (Edward 309, Linden Oaks 108 and Elmhurst Memorial Hospital 259). An audit for EEH will be provided for fiscal 2014 with consolidating statements for Edward and EMH.

Fitch's financial analysis and ratios are based on the results of the EMH Obligated Group.

WEAK FINANCIAL PROFILE

EMH's financial results in fiscal 2013 were significantly below Fitch's expectations with operating margin of negative 11.7% and operating EBITDA margin of 5.2%, which are below fiscal 2012 respective results of negative 10.2% and 7.5% and the 'BBB' category medians of 1.8% and 9%. The further compression in profitability reflects continued soft inpatient volumes and several one-time expenses, including increased costs related to the merger, the write-off of the Berteau campus and an increase in pension expense because of a drop in the discount rate. EMH is now managed by the Edward leadership team, which has taken action to cut expenses, including freezing the defined benefit plan effective January 2014, combining executive teams, consolidating certain shared services and modifying the group purchasing organization. Fitch expects to see operational improvements and further progress in operating profitability in fiscal 2014.

MIXED LIQUIDITY

At June 30, 2013, EMH's unrestricted cash and investments totaled $224.8 million, which is a 16% increase from fiscal 2012 year-end but still below historical balances. Liquidity against expenses is in line with the 'BBB' category median with days cash on hand of 210.8 compared to the 'BBB' category median of 144.7. However, pro forma cushion ratio of 8.2x and pro forma cash-to-debt of 45% are below the respective 'BBB' category medians of 10.2x and 91.7%. EMH is in process of building its cancer center on its new campus and is scheduled to be completed in the fall of 2013. The total project is expected to cost $22 million and will be funded mostly from cash and investments. After the completion of the cancer center in 2013, Fitch expects EMH to build up its balance sheet, as future capital spending requirements are minimal.

SOFT INPATIENT VOLUMES CONTINUE

A key element of EMH's weak financial performance has been the lack of volume growth that was projected to accrue upon the opening of the new facility. EMH's inpatient volumes have been relatively flat over the past five years, while management had projected a 6% increase in volumes with the move to the new facility. In 2013, inpatient volumes were down about 1% compared to the prior year. Since the merger, physician applications to join EMH's staff are growing, reflecting the long-term relationship between Edward and DMG, a multi-specialty physician group with over 400 members managing over 100,000 HMO patients in the region. Management projects a 15% growth in medical staff during the current fiscal year, which should lead to improved volumes.

HEAVY DEBT BURDEN

EMH's substantial debt burden is a credit concern with pro forma maximum annual debt service (MADS) a significant 6.9% of fiscal 2013 revenue compared to the 'BBB' category median of 3.5%;, pro forma MADS coverage by EBITDA is currently a very low 1.1x compared to the 'BBB' category median of 3.1x. However, actual debt service coverage as calculated by Fitch in fiscal 2013 was 1.3x, which is still very light for the category. Using the calculation under the master trust indenture, which excludes pension expense as part of net income available for debt service and uses the actual interest rate for the variable-rate debt, MADS coverage in fiscal 2013 was 1.61x.

Fitch views EMH's capital structure as being aggressive in light of its balance sheet liquidity, consisting of approximately 52% variable-rate demand obligations (VRDOs) and six swaps with a total notional amount of $490 million. There are five different swap counterparties and four different LOC providers backing the variable-rate bonds, with credit quality ranging from 'AA-' to 'A-'. The LOCs expire in April 2014, and management is currently in renewal discussions.

COMPETITIVE SERVICE AREA

EMH operates in the suburban area directly west of Chicago. Service area characteristics are strong, which is reflected in a favorable payor mix. However, the service area is very fragmented, with several strong competitors including Good Samaritan Hospital, part of Advocate Health Care Network (rated 'AA'; Stable Outlook by Fitch), Alexian Brothers Health System (rated 'A-'; Stable Outlook), Vanguard Westlake Hospital (not rated by Fitch) and Hinsdale Hospital, part of Adventist Health System - Sunbelt (rated 'AA'; Stable Outlook). Despite this competition, EMH has maintained a leading inpatient market share of roughly 26.5% in its primary service area over the last four years.

DISCLOSURE

EMH covenants to provide annual audited financial statements within 150 days of fiscal year-end and unaudited quarterly statements within 60 days of quarter end to bondholders. Quarterly disclosure has been timely and includes a balance sheet, income statement, statement of cash flow, utilization statistics, and a management discussion and analysis. In addition, EMH's disclosure on its derivative instruments is very detailed and thorough, which Fitch views positively.

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

Applicable Criteria and Related Research:

Nonprofit Hospitals and Health Systems Rating Criteria, May 20, 2013

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=804845

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Contacts

Fitch Ratings
Primary Analyst
Dana N. Sodikoff, +1-312-368-3215
Associate Director
Fitch Ratings, Inc.
70 West Madison
Chicago, IL 60602
or
Secondary Analyst
Jim LeBuhn, +1-312-368-2059
Senior Director
or
Committee Chairperson
Emily Wong, +1-415-732-5620
Senior Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Dana N. Sodikoff, +1-312-368-3215
Associate Director
Fitch Ratings, Inc.
70 West Madison
Chicago, IL 60602
or
Secondary Analyst
Jim LeBuhn, +1-312-368-2059
Senior Director
or
Committee Chairperson
Emily Wong, +1-415-732-5620
Senior Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com