Fitch Rates Hartford HealthCare's (CT) series D/E Revs 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings assigns an 'A' rating to the following bonds expected to be issued on behalf of Hartford HealthCare (HHC):

--$162,611,000 Hartford HealthCare Corporation taxable bonds series D;

--$92,635,000 Connecticut Health and Educational Facilities Authority revenue bonds, series E .

Additionally, Fitch affirms the 'A' rating for the following bonds issued on behalf of HHC:

--$254,730,000, Connecticut Health and Educational Facilities Authority revenue bonds, series 2011A;

--$71,085,000, Connecticut Health and Educational Facilities Authority variable rate revenue bonds, series 2011B *;

--$50,000,000, Taxable variable rate revenue demand bonds, series 2011C**.

*The series 2011B bonds are supported by a direct pay letter of credit issued by Bank of America N.A. **The series 2011C bonds are supported by a direct pay letter of credit issued by JPMorgan Chase Bank, N.A.

The Rating Outlook is Stable.

The series D and series E bonds are expected to be issued as taxable fixed rate bonds and tax-exempt fixed rate bonds, respectively. Proceeds of series D will be used to fund various capital projects, reimburse HHC for a prior pension funding, refinance an outstanding line of credit and pay costs of issuance. Proceeds of series E will be used to refinance a taxable line of credit used to redeem the Backus Hospitals' outstanding bonds, fund various capital projects including construction of a new cancer center and pay costs of issuance. The series D/E bonds are expected to price the week of March 17, 2014.

SECURITY

The bonds are secured by a pledge of the gross revenues of the obligated group and mortgages on the primary hospital facilities of certain obligated group members.

KEY RATING DRIVERS

BROAD OPERATING FOOTPRINT: HHC operates five acute care hospitals and is one of the two largest hospital systems in Connecticut. Additionally, HHC benefits from a leading 36.5% market share in its primary service area (PSA).

WEAKENED OPERATING PROFITABILITY: Operating profitability materially declined in fiscal 2013 primarily due to pressured Medicaid and Medicare reimbursement and a weakening payor mix. Management implemented operating improvement initiatives, resulting in improved profitability in the three-month interim period ending Dec. 31, 2013 (the interim period).

LOW DEBT BURDEN: HHC's credit profile benefits from a very low debt burden with pro forma maximum annual debt service (MADS) equal to 2.0% of revenue in fiscal 2013. Despite the decline in operations in fiscal 2013, MADS coverage by EBITDA remained solid at 4.3x (including 12 months of Backus operations); however, MADS coverage by operating EBITDA of 2.5x was light for the rating category.

MIXED LIQUIDITY METRICS: Unrestricted cash and investments increased significantly, primarily due to the Backus acquisition. Liquidity metrics are solid relative to pro forma debt with a 19.3x cushion ratio at Dec. 31, 2013. However, liquidity remains somewhat low relative to operating expenses with 142.8 days cash on hand.

INCREASED CAPITAL SPENDING: Capital spending is expected to increase over the next five years with significant projects including a new cancer center and implementation of a new information technology system. In addition, subject to CON and final board approval, HHC has plans to construct a new bone and joint institute. Despite the sizeable capital plans, Fitch expects HHC's debt profile to remain acceptable for the rating category.

RATING SENSITIVITIES

--IMPROVED OPERATING CASH FLOW: Improved operating cash flow will be necessary to increase MADS coverage by operating EBITDA to levels consistent with the 'A' rating and to support projected capital and debt plans. While Fitch expects that operating improvement initiatives will continue to gain traction and that operating cash flow will improve, failure to demonstrate improvements could lead to negative rating pressure.

CREDIT PROFILE

Headquartered in Hartford, Connecticut, HHC operates five acute care hospitals, a behavioral health hospital, an employed multispecialty physicians group with over 190 physicians, 49 physician office locations, 28 ambulatory care centers, a clinical lab company, long-term care, home health and a rehab network. Operating revenue totaled $2.1 billion in fiscal 2013. HHC and the William W. Backus Hospital (Backus) signed an affiliation agreement effective Aug. 1, 2013 under which the two organizations are now merged. Backus is a 233-licensed bed acute care hospital located in Norwich, Connecticut approximately 40 miles from Hartford Hospital. HHC added Backus to its obligated group in January 2014 upon redemption of Backus' outstanding bonds. The Backus acquisition is accretive to HHC's profitability and liquidity metrics.

Fitch's analysis is based upon HHC's consolidated financial statements. Consolidated results for fiscal 2013 include two months of Backus' operating results. Assuming Backus had been in the obligated group for the entire year, the obligated group accounted for approximately 88% of consolidated operating revenue and 100% of consolidated total assets in fiscal 2013.

BROAD OPERATING FOOTPRINT

HHC's large operating footprint and market share are key credit strengths and are expected to provide increased operating stability. HHC holds a leading 36.5% market share in its PSA and the second leading market share in Connecticut (21.6%). Additionally, HHC is one of the two largest healthcare systems in Connecticut with over $2.4 billion of revenue and a broad market footprint spanning seven of Connecticut's eight counties, including over 160 facilities.

WEAKENED OPERATING PROFITABILITY

After improving three years in a row, operating profitability materially declined in fiscal 2013. Operating margin decreased from 2.9% in fiscal 2012 to negative 1.6% in fiscal 2013, including two months of Backus' operations. Including the full year of Backus' operations, operating margin would have equaled negative 0.6%. The material decline was due to a combination of factors including greater than expected Medicaid cuts, sequestration cuts, a shift in the payor mix from commercial to both Medicare and Medicaid, as well as the continuing volume shift from inpatient to outpatient services.

Management is implementing several initiatives which are expected to improve operating profitability in the near- to mid-term. HHC implemented $94 million of operational improvements in fiscal 2013 which are expected to be realized in fiscal 2014 and is implementing an additional $67 million in fiscal 2014 that are expected to be realized in fiscal 2015. Initiatives include consolidation of administrative and shared services at the system level supported by regionalization of operations, labor productivity, supply chain, benefit redesign and revenue cycle. For example, HHC eliminated 179 positions, including 99 management positions, in November 2013, resulting in $23.9 million in savings per year. Additionally, revenue cycle improvements are expected to yield $30 million per year in recurring benefit.

Operating profitability in the interim period improved with operating margin equal to 1.7%. HHC's fiscal 2014 budget targets an operating margin of 1.5% which Fitch views as reasonable. Management expects to restore operating margin to 3.0% by fiscal 2016.

LIGHT DEBT BURDEN

In addition to the series D/E bonds, HHC expects to enter into a $75 million taxable bank loan in April 2014. Proceeds will be used to finance HHC's implementation of a new Epic IT system. Fitch's analysis and MADS assumption includes the $75 million debt issuance.

Total debt outstanding is expected to increase by approximately $136 million to $741.8 million (including capital leases). Pro-forma MADS is expected to equal approximately $48 million (including capital leases), increasing from the current MADS of $25.3 million. Despite the additional debt, HHC's pro forma debt burden remains light with pro forma MADS equal to 2.0% of operating revenue in fiscal 2013 (including a full year of Backus' operations) relative to Fitch's 'A' category median of 3.1%. Despite the material decline in operating profitability, MADS coverage by EBITDA equaled 3.5x in fiscal 2013 (4.3x including a full year of Backus' operations) and is consistent with Fitch's 'A' category median of 3.8x. However, MADS coverage by operating EBITDA equaled 1.7x (2.5x including a full year of Backus' operations) and was light relative to Fitch's 'A' category median of 3.4x. MADS coverage by EBITDA and operating EBITDA improved to 4.1x and 4.0x, respectively, in the interim period.

Subject to CON and board approval, HHC expects to issue an additional $100 million of bonds in summer 2015 to fund construction of a bone and joint institute on the campus of Hartford Hospital. Construction is expected to begin in fall 2014, but timing is subject to certificate of need approval. Fitch will assess the impact of the additional debt on HHC's overall credit profile as plans become more certain.

MIXED LIQUIDITY METRICS

Unrestricted cash and investments increased 58% since fiscal 2012 to $926 million at Dec. 31, 2013. The increase was due to the addition of Backus (which added approximately $244.5 million to HHC's consolidated balance sheet) and investment returns. Liquidity metrics are solid relative to HHC's debt burden with 124.9% cash to pro forma debt and 19.3x cushion ratio. However, liquidity remains light relative to operating expenses with 142.8 days cash on hand.

INCREASED CAPITAL SPENDING

Forecasted capital spending is expected to increase in the near- to mid-term. Management is in the process of updating its five-year capital plan; however, capital spending under the previous plan was forecasted to average $218.4 million per year between 2014 and 2018, representing a significant increase from historical levels. HHC's capital plans are contingent upon the system meeting certain operating targets. Capital plans could be decreased if certain targets are not achieved.

Significant projects include completion of the new cancer center, implementation of the new Epic IT system and continued investments in HHC's ambulatory expansion and physician alignment strategies. Subject to CON and final board approval, HHC has plans to construct a new bone and joint institute. Additionally, the Backus affiliation included a capital commitment of $200 million over 10 years that is not included as part of HHC's capital plan.

Fitch will continue to assess any potential credit impact of HHC's capital plans. A material increase in HHC's debt burden or decrease in liquidity metrics could negatively pressure the rating absent a corresponding improvement in profitability.

DISCLOSURE

HHC covenants to provide annual disclosure within 150 days of each fiscal year end and quarterly disclosure within 60 days of the end of the first three fiscal quarters. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA system.

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=822978

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Contacts

Fitch Ratings
Adam Kates, +1-312-368-3180
Director
Fitch Ratings, Inc.,
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
James LeBuhn, +1-312-368-2059
Senior Director
or
Committee Chairperson
Chris Hessenthaler, +1-212-908-0773
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Adam Kates, +1-312-368-3180
Director
Fitch Ratings, Inc.,
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
James LeBuhn, +1-312-368-2059
Senior Director
or
Committee Chairperson
Chris Hessenthaler, +1-212-908-0773
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com