Fitch Rates Carle Foundation (IL) Revs 'AA-'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'AA-' rating to approximately $195 million of series 2016A revenue bonds expected to be issued by the Illinois Finance Authority (the authority) on behalf of Carle Foundation (Carle).

In addition, Carle expects to issue $50 million of series 2016B taxable variable rate demand bonds. Proceeds from the series 2016 financing will be used to finance construction of new facilities, refund Carle's series 2009D variable rate demand revenue bonds and pay the costs of issuance. The series 2016A bonds will be issued as long-term fixed rate obligations and are expected to sell via negotiated sale the week of Oct. 24.

In addition, Fitch has affirmed the 'AA-' long-term rating on the following revenue bonds issued by the authority on behalf of Carle:

--$234.7 million series 2011A;

--$7.9 million series 2009A;

--$160 million series 2009B-E*.

*Underlying rating. The bonds are supported by bank letters-of-credit issued by The Northern Trust Company or JP Morgan Chase Bank, N.A.

The Rating Outlook is Stable.

SECURITY

Debt payments secured by a security interest in the gross receipts of the Obligated Group (OG; which includes the Carle Foundation, the Carle Foundation Hospital, Carle Health Care, Inc. and Carle Retirement Centers, Inc.). There is no mortgage or property pledge or debt service reserve fund. The OG represents approximately 48% of total system revenues and 77% of total system assets.

KEY RATING DRIVERS

FINANCIALLY STRONG, INTEGRATED SYSTEM: Fitch views as a credit strength Carle's fully integrated clinical model that includes a tertiary hospital, a large base of employed physicians, and a health plan. Despite recent softening in operating profitability due to losses within the health plan, unrestricted liquidity at June 30th remains solid at approximately $1.2 billion equating to 159% of pro forma debt.

MANAGEABLE PRO FORMA DEBT BURDEN: Pro forma debt metrics, including the impact of the 2016 borrowing, are supportive of the rating. Pro forma MADS to total revenues of 1.7% compares favorably to the 'AA' category median of 2.2% for the six-month 2016 interim period. Despite compressed profitability in fiscal 2015 and through the six-month interim period, historical coverage of pro forma MADS of 4.6x and 4.1x, respectively, is adequate given Carle's market position and integrated delivery model.

LEADING MARKET SHARE: Carle has further extended its leading inpatient market share position to 46.8% in 2016 from 46.3% in 2015 in its primary service area of Champaign-Urbana. Carle's market share has grown every year since 2002. In addition, most of Carle's patient volume numbers continue to show growth.

CONTINUED CAPITAL SPENDING: Fitch expects capital expenditures to remain above 1x depreciation, as Carle continues to execute on its five-year capital plan. Favorably, the majority of planned projects are expected to be revenue-enhancing and no additional debt is currently planned, apart from the series 2016 borrowing.

RATING SENSITIVITIES

CONTINUED STRENGTH IN PERFORMANCE: Fitch expects operating performance at the Health Alliance Medical Plan (HAMP) to improve with the decision to exit the Managed Medicaid business by the end of 2016. The improvement in insurance operations combined with steady operating performance at the Carle Foundation hospitals should allow the system to move back towards financial performance more consistent with historical results.

CREDIT SUMMARY

Located in Urbana, IL, Carle Foundation consists of 393-bed Carle Foundation Hospital, Carle Health Care, Incorporated (which includes Carle Physician Group, comprised mostly of former Clinic physicians), Carle Retirement Centers, a 174-unit retirement center d/b/a The Windsor, and a health plan.

Fitch's credit analysis is based on the results of the consolidated entity, which includes Health Alliance Medical Plans, Inc. (HAMP), a non-obligated health insurer licensed in the State of Illinois. In fiscal 2016, HAMP accounted for roughly 69% of the $2.5 billion in consolidated operating revenues.

SOLID CREDIT PROFILE

The 'AA-' rating reflects the strategic benefit of Carle's integrated delivery model, its growing market share position and its stable financial profile over the last few years.

In 2015, on a fully consolidated basis, Carle generated income from operations of $32.7 million on total revenues of $2.5 billion (1.3% margin). Through the six months ended June 30, 2016, Carle generated operating income of $26.5 million on revenues of $1.3 billion, improving operating margin to 2.1%.

On an OG-only basis, Carle generated an operating margin of 6.83% in 2015 and 9.51% in the six-month interim period.

Though solid, consolidated operating margins in both fiscal 2015 and the six-month interim period of 2016 were weaker than the 5% operating margin Carle posted in fiscal 2014. Additionally, days cash on hand slipped to 173.4 for the six months ended June 30, 2016 from 194.8 in fiscal 2015 and 231.3 in fiscal 2014. The biggest source of weakness in these two ratios came from HAMP, which is experiencing compressed operations due mainly to delayed payments from the State of Illinois, which remains without a budget. Approximately 47% of HAMP's premium revenues come from state insurance contracts.

Management has taken proactive steps to counteract the effects of these delayed payments and shore up its operations and liquidity position. To bolster its operating margin, Carle plans to exit its Managed Medicaid business by January 2017. Carle also continues to sell its state receivables aged 90 days or more to continue to grow its liquidity position. Fitch therefore expects liquidity and profitability to improve.

LIQUIDITY GROWTH

At June 30, 2016, Carle had unrestricted cash and investments of approximately $1.2 billion, up from just under $1.1 billion at year-end 2013. Cushion ratio of 26.6% as of June 30, 2016 compares favorably to Fitch's 'AA'-rated median. Current cash-to-debt is also a comfortable 215.7% as of the six-month interim, but this ratio declines to 159.2% when the new money debt is factored in. The strong overall growth in unrestricted cash and investments helps offset concerns about the state of Illinois' delayed payments to HAMP.

SOLID MARKET POSITION

Carle has further increased its leading inpatient market share in its primary service area of Champaign County over the last six years to 46.8% in 2016 from 39.1% in 2010. Presence Covenant has the second-largest market share position at 16.7%, and that has fallen from 20.1% in 2010.

Carle remains the market leader in key clinical lines, such as neurosciences, heart and vascular, oncology and women's services. Regionally, Carle continues to extend its reach through growth of clinical alignments with smaller, regional hospitals and expanding outpatient sites. HAMP also has a strong regional presence, and Carle and HAMP continue to explore regional business opportunities, as well as other potential initiatives around health care reform, including its ability to manage care coordination and control costs. HAMP has expanded into Washington State and Iowa, as well.

CONSTRUCTION PROJECTS

Collective proceeds from both a portion of the series 2016A bonds and a portion of the series 2016B taxable bonds will be used to finance construction of several projects that Carle identified in its five-year capital improvement plan. Major projects include a sports and orthopedic medicine center, expansion to administrative spaces for both Carle and HAMP, as well as clinical expansions at various sites. Total project costs are estimated at $200 million and will be entirely funded from the proceeds of the 2016 borrowings.

DEBT STRUCTURE/BURDEN

Including the net new money debt from the 2016 borrowings, Carle's pro forma long-term debt will total approximately $715 million. Following these transactions, Carle will have approximately 61% of fixed-rate debt and 39% variable rate debt. Of the variable-rate debt, approximately $160 million is letter of credit (LOC) supported and the remaining is bank loans. Expiration dates on the LOC's and bank loans range from 2019 to 2024, with no more than two expiring on any one date.

Carle has four swaps in place - two fixed payor swaps and two basis swaps. Total notional value of the swaps is $192 million. There are four counterparties, which provides for good counterparty diversity as it limits exposure to any single counterparty. The collateral thresholds on the swaps range from $15 million to $20 million and Carle has never had to post collateral. The mark-to-market on the swaps is negative $22.1 million at June 30, 2016.

Pro forma leverage metrics have moderated over the historical period and are manageable at the current rating level. Following the 2016 transactions, MADS will increase from $38 million to $43 million. In the six-month interim, pro forma MADS coverage was a solid 4.1x.

DISCLOSURE

Carle covenants to disclose annual financial information within 150 days of each fiscal year-end and quarterly information within 50 days of each fiscal quarter-end to EMMA. Disclosure to date has been excellent and includes both consolidated and consolidating balance sheet, income statement and statement of cash flows, as well as management discussion and analysis.

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

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)

https://www.fitchratings.com/site/re/866807

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Contacts

Fitch Ratings
Primary Analyst
Margaret Johnson, CFA
Director
+1-212-908-0545
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Gary Sokolow
Director
+1-212-908-9186
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com