Fitch Affirms OSF Healthcare System's (IL) Outstanding Revs at 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the 'A' rating on the following bonds issued by the Illinois Finance Authority on behalf of OSF Healthcare System (OSF):

--$114.3 million revenue bonds, series 2007A;

--$70 million variable rate demand revenue bonds, series 2007E and bank bonds;

--$55 million variable rate demand revenue bonds, series 2007F and bank bonds;

--$83.2 million revenue refunding bonds, series 2009A;

--$50 million variable rate demand revenue bonds, series 2009B;

--$50 million variable rate demand revenue bonds, series 2009C;

--$25 million variable rate demand revenue bonds, series 2009D;

--$156.9 million revenue refunding bonds, series 2010A;

--$176.3 million revenue bonds, series 2012A.

The Rating Outlook is Stable.

SECURITY

A security interest in the unrestricted receivables of the Obligated Group.

KEY RATING DRIVERS

IMPROVING LIQUIDITY: OSF's balance sheet metrics have improved year-over-year for the last five years and balance sheet metrics are now in line with the 'A' category medians. Liquidity growth has been driven by moderated capital spending, cash from operations and good investment returns.

REGIONAL GROWTH STRATEGY: OSF continues to undertake strategic growth initiatives intended to further develop and strengthen its regional relationships and footprint, including the recent acquisition of Kewanee Hospital, its partnership with University of Illinois for its Simulation Center, which opened in the summer of 2013, the anticipated partnerships with St. Anthony's Health System in Alton, IL and Mendota Community Hospital in Mendota, IL and the expansion of its ambulatory care network and affiliation arrangements with various community hospitals.

INTEGRATED SYSTEM: OSF's significant physician employment (approximately 655 physicians employed and 290 advanced practitioners) combined with a system-wide approach to leadership emphasizing physician input and transformation of care and operating model with a focus on innovation, has led to physician alignment and a more integrated approach to care.

INCONSISTENT OPERATING PERFORMANCE: After an improved fiscal 2012, operating performance was light in fiscal 2013 reflecting significant spending on the transformation of its care model. Operating margin in fiscal 2013 was negative 0.3% and operating EBITDA was 6.1%, down from 2.7% and 9.1%, respectively, in fiscal 2012. However, management has recognized the need for improved profitability and has identified over $50 million of savings mainly in the areas of supply and productivity in fiscal 2014. Through the nine month interim ended June 30, 2014 the focus on cost management has resulted in improved operating performance to 3.2% and operating EBITDA of 9.9%.

MANAGEABLE DEBT BURDEN: OSF's coverage of maximum annual debt service (MADS) at 2.7x at 2013 fiscal year-end was adequate against the 'A' category median of 3.8x but improved to a solid 4.1x through June 30, 2014 (nine-month interim). Fitch expects coverage to remain closer to the 'A' category median. MADS as a percent of revenue was a moderate 2.9% at the nine-month interim period and the system has a relatively conservative debt structure with 65% of debt fixed rate.

RATING SENSITIVITIES

NEED TO MAINTAIN PROFITABILITY: Fitch expects OSF to maintain solid operating profitability, which should provide sufficient cash flow to finance its near-term capital needs and support balance sheet levels.

CREDIT PROFILE

Headquartered in Peoria, Illinois, OSF Healthcare System owns and operates a combined nine health care facilities (eight in Illinois, one in Michigan) and has close to 13,800 employees. OSF's flagship hospital, St. Francis Medical Center, is a 609 licensed-acute care bed, Level I trauma center that serves as a regional referral center for high-acuity, complex clinical services. Total revenue in fiscal 2013 was $1.999 billion.

The system continues to extend its reach throughout the region via on-going physician employment and alignment, expansion of its ambulatory care network, and affiliation arrangements with various community hospitals in a hub-and-spoke model. In 2012, OSF added Ottawa Regional Hospital and Medical Center and Ottawa Regional Hospital Foundation to the obligated group and in 2014 Kewanee Hospital was added to the corporation through a statutory merger into the OSF healthcare system. Continuing to pursue this regional strategy, OSF currently has letters of intent signed with St. Anthony's Health System and Mendota Community Hospital.

OSF is focused on delivery of care in the most appropriate setting, providing complex care and developing its approach to population health management. These initiatives include patient centered medical homes, leveraging its technology to manage high risk populations, partnering with skilled nursing facilities and providing tele-health. Fitch views these initiatives positively as they will better position OSF for healthcare reform and the changing reimbursement environment. In 2013 OSF opened a Simulation Center in partnership with University of Illinois (both medical and engineering schools), which will be used for clinical training and research and development.

The 'A' rating reflects OSF's improved liquidity, regional growth strategy, good market share position in a competitive service area, coupled with adequate operating and debt metrics.

IMPROVING LIQUIDITY

Historically, OSF's liquidity position has been light for the rating category. However, cash has grown almost 30% since fiscal 2012 and at June 30, 2014 (nine-month interim). Unrestricted cash and investments totaled $1.1 billion, equating to 212.7 days cash on hand, 18.6% cushion ratio and 120.1%; all in line with the respective 'A' category medians of 196.3 days, 15.6x and 129.2%. Fitch believes liquidity should continue to demonstrate modest improvement over the near term as capital needs are currently budgeted at about 1.1x depreciation expense.

INCONSISTENT OPERATING PROFITABILITY

Operating profitability has fluctuated somewhat over the last few years as OSF has been investing in IT, physician acquisitions, and the transition and advancement of its care model. Operating income was significantly under budget in 2013 and was caused by services taken off-line for upgrades, the continuation of Epic installation and volume declines; management is focusing on cost reductions and profitability rebounded through the nine month interim period ended June 30, 2014. Operating margin was 3.2% and operating EBITDA margin was 9.9% at June 30, 2014, up from negative 0.3% and 6.1%, respectively, in fiscal 2013. Management has identified over $50 million in cost reductions in performance improvement initiatives including supply savings, increased productivity, and other clinical and IT cost savings. Fitch expects OSF to meet its 2014 budgeted operating and operating EBITDA margins of 1.7% and 8.4%, respectively. Fitch notes that OSF receives approximately $40 million-$50 million a year in supplemental disproportionate share and upper payment limit funding and any reductions in funding would pressure profitability.

GOOD MARKET SHARE POSITION

The service area of St. Francis Medical Center (OSF's largest facility) has consolidated since Fitch's last review. UnityPoint Health (rated 'AA-'; Outlook Stable) acquired Methodist Healthcare and Proctor Hospital, two of OSF's primary competitors in its Peoria Service area. Despite this change to the market, OSF has maintained its strong position in its primary service area for St. Francis Medical Center, holding 47.6% of the market share in the second quarter 2014, up from 46.5% in fiscal 2013 and ahead of its closest competitor, UnityPoint Health- Methodist, at 26.1%. Inpatient market share at St. Joseph Medical Center in Bloomington/Pontiac is down slightly in the second quarter 2014 at 31.2% verses Advocate BroMenn's share at 40.3%, likely because of a focus on moving care to an outpatient setting. Market share in Rockford at St. Anthony's Medical Center was also down slightly to 28.1% in the second quarter 2014 vs. 28.3% in fiscal 2013.

MANAGEABLE DEBT BURDEN

OSF has about $820.2 million in debt outstanding, of which 65% is fixed rate and 35% is variable rate. OSF's debt burden remains manageable for the category with MADS of $59.7 million making up about 3% of total fiscal 2013 revenue compared to the 'A' category median of 3.1%. MADS coverage by EBITDA was adequate at 2.7x times in fiscal 2013 and improved to 4.1x for the nine months ended June 30, 2014.

OSF has a $30 million line of credit with PNC bank, which is renewed annually. In March, 2014, OSF drew $29.7 million in conjunction with the purchase of Kewanee Hospital. The draw will be repaid prior to Sept. 30, 2014 with the proceeds of a private placement with PNC. The $30 million is included in long-term debt at June 30, 2014 but the current MADS does not include the contemplated $30 million direct placement with PNC. Fitch does not believe this financing will materially impact OSF's debt metrics. OSF currently has four fixed payor swaps insured by Assured Guaranty and one basis swap outstanding for a total notional amount of $365.7 million. The uninsured swap has a $20 million collateral threshold and no collateral is currently posted.

DISCLOSURE

OSF covenants to provide quarterly financial information within 60 days of quarter-end (for the first three quarters) and annual financial information within 150 days of fiscal year-end to bondholders. Quarterly interim financials include consolidated and consolidating balance sheet and income statements and are available through the MSRB's EMMA system.

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

In addition to the sources of information identified in Fitch's Rating Criteria, this action was additionally informed by information from Barclays, the underwriter.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', June 16, 2014;

--'Non-Profit Hospitals and Health Systems Rating Criteria', May 30, 2014.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Not-for-Profit Hospitals and Health Systems Rating Criteria Outside the United States

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=688554

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=842937

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Contacts

Fitch Ratings
Primary Analyst
Dana S. Ringer
Director
+1-312-368-3215
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Emily Wadhwani
Director
+1-312-368-3347
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Dana S. Ringer
Director
+1-312-368-3215
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Emily Wadhwani
Director
+1-312-368-3347
or
Committee Chairperson
Emily Wong
Senior Director
+1-415-732-5620
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com