Fitch Rates Mercy Health's (OH) Series 2015A/B/C Bonds 'AA-'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned an 'AA-' rating to the following bonds expected to be issued by or on behalf of Mercy Health (formerly known as Catholic Health Partners):

--$151,115,000 Allen County (OH) hospital facilities revenue refunding and improvement bonds, series 2015A;

--$100,000,000 Allen County (OH) adjustable rate hospital facilities revenue bonds, series 2015B;

--$150,000,000 Mercy Health taxable bonds, series 2015C.

Fitch has also affirmed the 'AA-' rating on approximately $1.5 billion of bonds issued by Allen County (OH), Lorain County (OH) and Knox County Health, Educational & Housing Facility Board (TN) on behalf of Mercy Health.

The series 2015A bonds are expected to be issued as tax-exempt fixed-rate bonds, the series 2015B bonds are expected to be issued as tax-exempt variable rate bonds and the series 2015C bonds are expected to be issued as taxable fixed rate bonds. Bond proceeds will be used to fund various capital projects, including patient tower projects at the system's Jewish Hospital and Anderson Hospital in Cincinnati and various other capital projects; to refund a portion of the outstanding series 2010 bonds; and to pay costs of issuance. The series 2015 bonds are expected to price the week of April 20 through negotiation.

The Rating Outlook is Stable.

Additionally, Fitch has affirmed its 'F1+' short-term rating on the following bonds issued on behalf of Mercy Health and supported by Mercy Health's internal liquidity.

--$100 million Allen County (OH) adjustable-rate hospital facilities revenue bonds series 2012B.

KEY RATING DRIVERS

BROAD OPERATING PLATFORM: Mercy Health is the largest health system in Ohio and holds the leading market share in the state. Operations include 23 acute care hospitals, 15 long-term care facilities, and a health plan. Fitch believes that the large operating platform mitigates the system's overall operating risk profile.

HISTORICALLY CONSISTENT OPERATING PROFITABILITY: Operating profitability has been historically consistent with operating EBITDA margin averaging 10.7% since fiscal 2009 and equal to 9.9% in fiscal 2014. The system achieved solid operating results in fiscal 2014 despite challenging operations in the first quarter. However, management is budgeting for operating profitability to compress in fiscal 2015 due to continued strategic investments.

ELEVATED DEBT BURDEN: Mercy Health's pro forma debt burden remains elevated with maximum annual debt service (MADS) equal to 3.4% of fiscal 2014 operating revenue. However, the pro forma debt burden did not materially increase despite the issuance of the additional debt due to continued revenue growth.

ADEQUATE LIQUIDITY: Unrestricted liquidity increased 6.2% since fiscal 2012 to $2.3 billion at Dec. 31, 2014, despite continued strategic investments. Liquidity metrics remain adequate for the rating category given Mercy Health's size and scope of operations.

SHORT-TERM RATING: At March 31, 2015, Mercy Health's eligible cash and investment position under Fitch's criteria would cover the maximum mandatory put on self-liquidity bonds on any given date well in excess of Fitch's 1.25x threshold for the 'F1+' short-term rating.

RATING SENSITIVITIES

MID-TERM OPERATING PROFITABILITY: While Fitch views Mercy Health's continued strategic investments in physician alignment, the health plan and population health management initiatives positively, Fitch expects that budgeted targets will be met or exceeded and that the budgeted decline in operating profitability in fiscal 2015 will be temporary with operating profitability rebounding to historical levels over the next two to three years.

SECURITY:

The bonds are general, unsecured obligations of Mercy Health and its affiliates.

CREDIT SUMMARY:

Mercy Health is an integrated delivery system headquartered in Cincinnati, OH, with operations in Ohio and Kentucky. Mercy Health changed its name from Catholic Health Partners effective July 2014. The system has experienced substantial growth over the past six years with total operating revenue increasing 43.6% since fiscal 2009 to $4.5 billion in fiscal 2014.

HealthSpan Partners (HSP), a distinct nonprofit organization with the primary purpose of developing expanded provider networks and insurance products, invested $250 million in Summa Health System (rated 'BBB+' by Fitch) for a 30% minority interest in September 2013. HSP has overlapping governance with Mercy Health and is consolidated in Mercy Health's consolidated financial statements in accordance with U.S. generally accepted accounting principles. Additionally, HSP purchased the Kaiser Health Plan Foundation of Ohio in September 2013 (currently named HealthSpan Integrated Care). The purchase price will be funded through EBITDA over a five-year period with a minimum price of $50 million and maximum price of $100 million. Fitch views the acquisition and strategic partnership by HSP favorably as they both are expected to further strengthen Mercy Health's market position in Ohio and provide opportunities to achieve economies of scale and synergies.

BROAD OPERATING PLATFORM

Mercy Health's broad and diverse operating platform adds to its operating stability. Operations include 23 hospitals, 26 diagnostic imaging centers, 16 ambulatory surgical centers, six long-term care facilities, eight home health agencies and two health plans. Mercy Health is the largest healthcare system in Ohio, with $4.5 billion in revenue in fiscal 2014 and a leading 12% statewide market share. Operating revenue increased 14.3% in fiscal 2014 from $4 billion in 2013 reflecting a full year of HSP operations (including the health plan and Summa minority investment) and continued growth in physician employment. Additionally, the system holds leading market share positions in four of its six regional markets in Ohio and the number two market share in its Kentucky market.

HISTORICALLY CONSISTENT OPERATING PROFITABILITY

Operating profitability has been historically consistent with operating EBITDA averaging 10.7% since fiscal 2009 and equal to 9.9% in fiscal 2014. Operating profitability decreased slightly over fiscal 2013 primarily due to a full year of health plan costs and continued physician employment initiatives. Additionally, fiscal 2014 operations were negatively impacted by a poor first quarter in which soft inpatient volumes, extreme winter weather and a significant increase in observation stays compressed operating profitability to break even. While margins compressed slightly, absolute profitability increased with operating EBITDA increasing $45 million year over year.

Mercy Health has continued strong cost management practices and achieved $64 million in cost savings in fiscal 2014. Savings were achieved through consolidating administrative operations, reducing clinical variations, streamlined corporate structures and supply chain initiatives. Savings from these initiatives were reinvested in the system to implement care model and payment model changes. Management has identified over $200 million of additional operating improvement initiatives to be implemented over the next four years, including both revenue enhancement and cost management initiatives.

Despite the continued operating improvement initiatives, management has budgeted for operating EBITDA margin to compress to 9.1% in fiscal 2015. The compression is due to increased costs associated with the continued reinvestment into the system including physician alignment, health plan and population health management initiatives. While Fitch views the investments positively, Fitch expects that operating profitability will return to historical levels in the next two to three years.

ELEVATED DEBT BURDEN

Mercy Health's debt burden has consistently moderated over the past six years due to revenue growth, with pro forma MADS decreasing from 4.8% of revenue in fiscal 2009 to 3.4% of revenue in fiscal 2014. However, the pro forma debt burden remains elevated relative to Fitch's 'AA' category median of 2.6%. Despite the new debt issuance, the debt burden didn't change materially from Fitch's last review (3.6% of revenue in fiscal 2013). Pro forma MADS coverage by EBITDA and operating EBITDA of 3.5x and 2.9x in fiscal 2014 remain light for the rating category.

ADEQUATE LIQUIDITY

Unrestricted cash and investments increased 3.2% year over year to $2.3 billion at Dec. 31, 2014. Upon closing, unrestricted cash and investments is expected to total $2.4 billion, reflecting $150 million of taxable bond proceeds plus $50 million of reimbursement for prior capital expenditures minus $100 million to be used to pay down an outstanding line of credit. Given Mercy Health's size, scope of operations and continued reinvestment into its system (including the $250 million Summa investment and Kaiser acquisition), pro forma liquidity metrics remain adequate for the rating category with 211.7 days cash on hand, 15.8x cushion ratio and 112.2% cash-to-debt. However, liquidity metrics are light relative to Fitch's 'AA' category medians of 277.1 days cash on hand, 26.5x cushion ratio and 178.5% cash to debt.

SHORT-TERM RATING

The affirmation of the short-term 'F1+' rating is based on the sufficiency of Mercy Health's liquid resources and written procedures to fund the purchase price on each mandatory tender date. Mercy Health has a total of $100 million of series 2012B bonds supported by self-liquidity. Based on Fitch's rating criteria related to self-liquidity, Mercy Health's eligible cash and investment position under the criteria would cover the maximum mandatory put on self-liquidity bonds on any given date well in excess of Fitch's 1.25x threshold for the 'F1+' short-term rating. Mercy Health provides Fitch with monthly cash and investment reports.

DEBT PROFILE

Subsequent to the series 2015 bond issuance, Mercy Health will have approximately $2.1 billion of total debt outstanding. The pro forma debt profile will include 61% underlying fixed-rate bonds and 39% underlying variable-rate bonds. The system is counterparty to one fixed payor swap ($269 million notional) and one constant maturity swap ($250 million notional), converting approximately 14% of total pro forma debt to synthetic fixed rate. Mercy Health had $11.5 million of collateral posted at Dec. 31, 2014. Since 2012, the system has incrementally terminated $305 million of fixed payor swaps through March 2015, with the goal to achieve 30% variable interest rate exposure.

DISCLOSURE

Mercy Health covenants to provide annual disclosure no later than 150 days after the end of each fiscal year and quarterly disclosure no later than 60 days after the end of each of the first three fiscal quarters. Disclosure is provided to bondholders via the Municipal Securities Rulemaking Board's EMMA system and its web site, 'www.mercy.com'. Fitch views Mercy Health's disclosure practices as one of the best in the industry.

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

Applicable Criteria and Related Research:

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

--'Nonprofit Hospitals and Health Systems Rating Criteria' (May 30, 2014);

--'Rating U.S. Public Finance Short-Term Debt' (Jan. 7, 2015).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

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

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860

Rating U.S. Public Finance Short-Term Debt

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=846969

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982857

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Contacts

Fitch Ratings
Primary Analyst
Adam Kates
Director
+1 312-368-3180
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
James LeBuhn
Senior Director
+1 312-368-2059
or
Committee Chairperson
Emily Wong
Senior Director
+1 415-732-5620
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Adam Kates
Director
+1 312-368-3180
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
James LeBuhn
Senior Director
+1 312-368-2059
or
Committee Chairperson
Emily Wong
Senior Director
+1 415-732-5620
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com