[May 05, 2014]

Fitch Rates Centegra Health System & Affiliates, IL Ser 2014A Revs 'BBB'; Downgrades Rev Bonds

Fitch Ratings has assigned a 'BBB' rating to approximately $134.7 million series 2014A revenue bonds expected to be issued by the Illinois Finance Authority on behalf of Centegra Health System and Affiliates (Centegra).

In addition, Fitch downgrades the following revenue bonds to 'BBB' from 'A-':

--$195.0 million Illinois Finance Authority (Centegra Health System and Affiliates), series 2012

The Rating Outlook has been revised to Stable from Negative.

Proceeds from the series 2014A bonds will be used to pay for construction, renovation or remodeling of certain of Centegra's health facilities, finance the costs of construction and equipping the new hospital, funding capitalized interest and pay certain costs of issuance. The series 2014A bonds, which will be issued as fixed rate, are expected to price the week of May 19, 2014 via negotiation.

In addition to the series 2014A bonds, Centegra is expected to issue approximately $58.3 million direct placement bonds, which will not be rated by Fitch but are considered in its analysis.

SECURITY

Debt payments are secured by a pledge of the unrestricted receivables of the obligated group.

KEY RATING DRIVERS

ELEVATED DEBT BURDEN: The rating downgrade to 'BBB' from 'A-' reflects the impact to Centegra's financial profile upon issuance of approximately $193 million in new debt ($134.7 million of which is rated by Fitch), which will be used to construct a new 128-bed hospital in Huntley, Illinois, a growing community in northwest Illinois, about 16 miles from the flagship McHenry campus. Pro-forma maximum annual debt service (MADS) is estimated at $24.9 million (as provided by the underwriter); up from current MADS of about $14.5 million. Historical coverage of pro-forma MADS is light at 1.7x in fiscal 2013 relative to the 'BBB' category median of 3.1x. However, Fitch notes that interest will be capitalized through fiscal 2017 and debt service will stabilize at $24.9 million in 2019.

MODEST PROFITABILITY: Relative to Fitch's 'BBB' category medians, Centegra's profitability ratios are light reflecting the system's investments in physician alignment, IT and outpatient facilities over the last few years. Operating margins of 0.2% in fiscal 2013 and 0.5% through the nine months ended March 31, 2014 are light compared to the 'BBB' category median of 1.8%. While Centegra has generated relatively consistent operating EBITDA margins of 7.1% through the third quarter, 7.5% in fiscal 2013 and 7.9% in fiscal 2012, it is weak for the rating category. Fitch expects Centegra's strong management practices, integrated physician operating platform and the benefits of the new project to generate solid cash flow to provide adequate coverage for its significantly larger debt burden.

LEADING MARKET POSITION, COMPETITIVE SERVICE AREA: Centegra's leading market share position in a growing service area with a favorable demographic profile is a key credit strength. Centegra controls about 43.3% inpatient market share as of March 2014 in its primary service area of McHenry County. Competitive activity from two Advocate Health Network facilities (Advocate Good Shepherd and Advocate Sherman Hospital) could pressure the scale of the benefits expected to accrue upon opening of the new facility.

STRATEGIC INVESTMENT PROGRESS: To meet the expected population growth in its service area, Centegra is focusing on physician alignment, clinical effectiveness and community health management. With three hospitals, two fitness centers, and various clinics and specialty services located throughout McHenry County, Centegra has been increasing its access points and is well positioned for managing the future delivery of care. Fitch views entegra's proactive and strategic initiatives as a credit positive and will likely prove integral to the success of the new hospital.

RATING SENSITIVITIES

MAINTAIN FINANCIAL PROFILE: Management will need to meet or exceed current pro forma financial metrics through the opening of the new hospital. The heavy debt burden allows little negative variance to forecast results.

CREDIT PROFILE

Centegra is a three-hospital system with a total of 341 licensed and 306 staffed beds located in McHenry County, IL with total operating revenues of $398.9 million in fiscal 2013.

LIGHT PRO FORMA LIQUIDITY AND CAPITAL METRICS

The 'BBB' rating reflects the dilution in Centegra's capital related and liquidity ratios resulting from the additional debt to levels more consistent with Fitch's 'BBB' hospital universe. At March 31, 2014, Centegra's unrestricted cash and investments totaled $192.1 million, which equates to 170 days cash on hand, 12.9x cushion ratio and 91.3% cash-to-debt. On a pro-forma basis, cushion ratio declines to 7.7x compared to the 'BBB' category median of 10.2x while cash-to-debt weakens to a very light 48.4% relative to the 'BBB' category median of 91.7%.

Centegra will have approximately $400 million in debt outstanding, 85% fixed rate and 15% variable rate, after the series 2014 debt issuance. This is a 47% increase from the $210.5 million in debt currently outstanding. The obligated group includes Centegra, Memorial Medical Center, Northern Illinois Medical Center and NIMED, its real estate holding company that was brought into the obligated group with the 2012 financing. Pro forma MADS as a percent of fiscal 2013 revenue is high at 6.2% compared to the 'BBB' category median of 3.5%. Pro forma MADS coverage is 1.7x at March 31, 2014, which is also light against the 'BBB' category media of 3.1x. Debt service in fiscal 2016-2018 is $18.03 million, which would result in debt service coverage of about 2.3x using the March 31, 2014 interim results.

NEW HOSPITAL PROJECT

The decision to construct a new facility in Huntley stems from Centegra's solid utilization in a service area that is experiencing population growth. On July 24, 2012, Centegra received CON approval from the Illinois Health Facilities and Services Review Board to build a 128-bed acute care hospital in Huntley, IL, which is only the second CON granted for a new hospital facility versus a replacement facility in the state in about 30 years. Two competitors have filed a lawsuit contesting the construction of the new facility and the circuit court upheld the CON board decision. The case is currently under appeal. Management anticipates an outcome before the end of the year. Construction is underway and the new hospital is expected to open in August 2016 (fiscal 2017; June 30 year-end). Stabilization is expected by 2019, which is when debt service increases to $24.9 million. Fitch believes the new facility could help Centegra expand its footprint in the growing southern portion of McHenry County.

LIGHT OPERATING PROFITABILITY

Operating performance has been weak for the rating level and has been affected by its strategic investments, relatively flat volumes and an unfavorable shift in payor mix. Fitch expected improved performance in fiscal 2013 from the prior year but profitability was affected by several one-time expenses including physician acquisition and by the roll-out of its electronic medical record system in May. Operating profitability continues to be relatively weak through March 31, 2014 (nine month interim). Operating margin remained a thin 0.5% and operating EBITDA was 7.1%, down slightly from 7.5% in fiscal 2013. Fitch expects Centegra to maintain or improve operating performance. Deterioration could be cause for concern.

STRONG MARKET SHARE POSITION

Centegra maintains a leading market share in a favorable service area with good demographics and socio-economic indicators within McHenry County. Centegra's market share declined slightly after the opening of Sherman Health's replacement facility in December 2009 and is now 43.3% as of March 2014 compared to 44.8% in fiscal 2013 and 45.6% in fiscal 2012. Sherman holds 13.8% of the market share as of March 2014, up from 11.7% in 2012. Advocate Good Shepard Hospital has about 12.7% market share. Centegra has been focusing on growing its employed physician model (Centegra Physician Care; CPC (News - Alert)) over the last five years and as of March 2014 63% of all admitted physicians are from CPC, up from just over 30% in fiscal 2008.

DISCLOSURE

Centegra will covenant to provide annual audited financials within 150 days of fiscal year end and unaudited quarterly financials for the first three fiscal quarters within 45 days of quarter end and within 60 days of the fourth quarter.

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

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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