Fitch Affirms Allina Health System's (MN) Rev Bonds 'AA-'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the 'AA-' long-term rating on Allina Health System's, Minnesota (Allina) outstanding debt, as listed at the end of the press release. The 'AA-' rating on the letter of credit (LOC) backed variable-rate demand bonds (VRDBs) are underlying ratings.

The Rating Outlook is Stable.

SECURITY

Bondholders have a security interest in pledged revenues and a negative lien pledge on property of the obligated group (OG).

KEY RATING DRIVERS

COMPREHENSIVE DELIVERY MODEL: Allina's main credit strength is its comprehensive delivery model and geographic reach in the competitive Twin Cities metropolitan area that has led to a leading and stable market position of 32.7% in 2013. Allina has 1,300 employed physicians and 80 clinics in the service area. Fitch believes Allina is well positioned for the changing healthcare environment as it has capitalized on its information technology investments with a focus of providing care in cost-effective settings and improving quality outcomes.

TRANSFORMATIONAL STRATEGIC INITIATIVES: Allina has committed to redesigning patient care, which focuses on identifying patients at risk and providing them with the resources necessary to manage their care. This is expected to enhance patient care, improve outcomes, and reduce costs. Allina has implemented several care models and is slowly phasing in performance risk into its managed care contracts. To date, these initiatives have generally added costs to the system while the benefits from these strategic investments are expected over a longer-term horizon.

LOW DEBT BURDEN AND STRONG LIQUIDITY: Allina's low debt burden results in strong historical debt service coverage despite pressured profitability and coverage ratios exceed Fitch's 'AA' category medians. Furthermore, steady growth in unrestricted cash and investments has generated cushion and cash-to-debt metrics that exceed Fitch's 'AA' category medians.

PRESSURED PROFITABILITY: Allina has experienced solid revenue growth over the last five years driven mainly by the growth in clinic and ambulatory services. However, profitability has declined due to continued pressure on reimbursement, declining inpatient services and the costs associated with its strategic investments. The organization continues to identify areas for cost savings and efficiency gains, which includes a reduction in FTEs.

MANAGEABLE CAPITAL NEEDS: Allina does not have any additional debt plans and projected capital spending is manageable at approximately $230 million-$250 million a year for the next three years. Routine capital spending roughly approximates depreciation expense with strategic capital and contingency raising total capital spending to over 1.5x depreciation expense over the next three years.

RATING SENSITIVITIES

STABILITY AT CURRENT RATING LEVEL: Fitch believes there is stability at the current rating level despite lower profitability due to Allina's low leverage position and strong liquidity. Fitch believes Allina's expanding geographic presence in the market combined with their healthcare reform initiatives will provide a longer-term return on investment.

CREDIT PROFILE

Allina is a comprehensive delivery system consisting of 12 hospitals, including its flagship hospital, Abbott Northwestern Hospital, and 1,300 employed physicians (primary care, specialists, and hospital-based) with 80 outlying clinics in the Twin Cities metropolitan area. Total operating revenue for the consolidated system in 2013 (Dec. 31 fiscal year end) was $3.4 billion. The obligated group (OG) includes Allina's owned hospitals and other subsidiaries and accounted for 94.8% of the consolidated entity's revenue for fiscal 2013. Fitch's analysis is based on the consolidated entity. Fitch notes that several key personnel in the finance department have left or are leaving (current CFO leaving by the end of 2014) and will monitor the transition.

STRATEGIC INITIATIVES

Allina has been focused on maximizing its market position and delivery network in the changing reimbursement environment. These efforts include continued acquisitions of smaller entities within the Twin Cities metropolitan market as well as investing in changing the delivery of care with the goal of providing quality care and improving affordability. Patient care redesign and care management initiatives include the development of care teams and use of predictive modeling to prevent adverse outcomes and high cost utilization. The cost of these initiatives has totaled $73 million for fiscal 2013 and is expected to total approximately $84 million for fiscal 2014. Fitch believes these strategies will benefit the system as the market transitions to a more value-based reimbursement environment, which has been slower than management expected.

PAYMENT REFORM

Allina's market position is solidified by Allina Integrated Medical Network (AIMN), which is a physician-led organization that includes Allina's 1,300 employed physicians as well as 1,600 independent physicians. The AIMN governance structure allows physicians to have key decision-making powers and allowed Allina and AIMN to develop an exclusive narrow network contract with Blue Cross. Approximately 22% of Allina's revenue is considered risk based; however, only 3% has financial risk.

PRESSURED OPERATING PERFORMANCE

Allina benefits from a diverse revenue base with 40.5% of total revenue from inpatient activity in 2013, 30.1% from ambulatory activity, and 22.7% from clinic revenue. Operating margin was 6.3% in fiscal 2010, 5.4% in fiscal 2011 and declined to 3.9% in fiscal 2012 and 2013 and was 3.2% through the eight months ended Aug. 31, 2014. Management expects operating margins to remain around this level for the next three years.

Despite a favorable service area with good demographics and socio-economic indicators, the environment is competitive with the potential for further consolidation among Allina's competitors. In addition, other operating pressures include a strong nurses union, upcoming renegotiation of SEIU contract, and dominance of three main managed care payors. The nurses union, Minnesota Nurses Association (MNA), negotiates with all the hospitals in the Twin Cities at the same time and has bargaining clout. The MNA contract extends through 2016. Allina is part of a multi-employer defined benefit pension plan for the MNA, which is underfunded and Allina's liability is approximately $69.9 million.

MARKET LEADER

Allina is the largest health system in Minnesota with a leading 32.7% inpatient market share in the highly competitive Minneapolis-St. Paul metropolitan area as of Dec. 31, 2013. Market share has remained stable. The next closest competitor is Fairview Health System at 19.8% followed by Health Partners at 15.5%.

IMPROVED LIQUIDITY POSITION

Allina's liquidity has steadily grown over the last few years with cushion and cash-to-debt metrics that exceed Fitch's 'AA' category medians. At Aug. 31, 2014, Allina had $1.6 billion of unrestricted cash and investments, which translates to 178.4 days cash on hand, a cushion ratio of 31.6x and 245.4% of debt as compared to the respective 'AA' category medians of 277.1, 26.5x and 178.5%. Growth is expected to continue as capital spending plans are manageable. In addition, Fitch views favorably Allina's ability to terminate its defined benefit pension plan, and assets were dispersed in November 2013.

MANAGEABLE CAPITAL NEEDS

Allina's 2015-2017 capital plan totals $715 million and includes $455 million for routine capital needs with no large projects on the horizon. Other main components of capital spending include strategic ($215 million) and contingency ($45 million). No additional debt is anticipated and capital spending will be funded from cash flow.

LOW DEBT BURDEN

Allina's debt burden is low, with maximum annual debt service (MADS) of $50.2 million equating to a light 1.5% of 2013 revenue, compared with Fitch's 'AA' rating category median of 2.6%. MADS includes the debt service of newly acquired entities ($27 million), which is expected to be financed with a direct bank loan. MADS coverage by EBITDA is strong at 6.2x for the eight months ended Aug. 31, 2014 despite the lower profitability. Similarly, MADS coverage by EBITDA has been robust at 8x in fiscal 2013, 6x in fiscal 2012 and 7.6x in fiscal 2011 relative to the 'AA' category median of 5.4x. Allina's operating leases are high due to the number of clinics it has. Operating lease expense in 2013 was $27.6 million and when included as debt, adjusted MADS coverage is still solid at 5.5x for 2013.

DEBT PORTFOLIO

Allina had $618.7 million of total bonded debt outstanding as of Aug. 31, 2014, which was 47% fixed rate and 53% underlying variable rate (48.7% swapped to fixed rate). Of Allina's variable-rate exposure, $287.2 million are VRDBs and $40.7 million are auction rate. Fitch believes the risks related to the VRDBs are manageable due to the solid cash-to-putable debt of 5.5x at Aug. 31, 2014. The LOCs associated with the VRDBs expire in January 2015 (Wells Fargo) and November 2015 (JPMorgan) and all have five-year term-out provisions. Allina has $351.5 million of floating- to fixed-rate swaps outstanding with four different counterparties. Collateral posting requirements vary for the five swaps and Allina was posting $2.6 million of collateral as of Aug. 31, 2014.

DISCLOSURE

Allina covenants to disclose annual and quarterly financial information to bondholders. Fitch notes that Allina's disclosure is one of the best in its rated portfolio because of the quality of the information provided. All of Allina's disclosure documents are posted on EMMA. Quarterly and annual financial information consists of a balance sheet, income statement, and statement of cash flows and is supplemented by a management discussion and analysis plus updated market share information, utilization statistics, debt and investment summaries and general organizational information.

Outstanding Debt:

--$50,000,000 Minneapolis & St Paul Housing & Redevelopment Authority (MN) (Allina Health System) health system variable-rate revenue bonds series 2009C (LOC: Wells Fargo Bank, N.A.);

--$114,500,000 Minneapolis & St Paul Housing & Redevelopment Authority (MN) (Allina Health System) health system variable-rate revenue bonds series 2009 B-1 & B-2 (LOC: JPMorgan Chase Bank, N.A.);

--$179,200,000 Minneapolis & St Paul Housing & Redevelopment Authority (MN) (Allina Health System) health care system revenue bonds series 2009 A-1& A-2;

--$121,900,000 Minneapolis & St Paul Housing & Redevelopment Authority (MN) (Allina Health System) health system variable-rate revenue bonds series 2007C-1&C-2;

--$111,600,000 Minneapolis (MN) (Allina Health System) health care system revenue bonds series 2007A (insured: MBIA Insurance Corp.);

--$14,600,000 Minneapolis (MN) (Allina Health System) variable-rate revenue bonds series 1998A;

--$800,000 Coon Rapids (MN) (Health Central) variable-rate demand hospital revenue bonds series 1985.

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

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 30, 2014.

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=914375

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Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1 415-732-5620
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Dmitry Feofilaktov
Analyst
+1 212-908-0345
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1 312-368-2059
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1 415-732-5620
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Dmitry Feofilaktov
Analyst
+1 212-908-0345
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1 312-368-2059
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com