[December 02, 2016]

Fitch Affirms Bon Secours Health System (MD) Revs at 'A'; Outlook Stable

Fitch Ratings has affirmed the 'A' rating on approximately $713 million of outstanding bonds issued on behalf of Bon Secours Health System, Inc. (BSHSI).

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a pledge of unrestricted receivables of the obligated group.

KEY RATING DRIVERS

STRATEGIC DIVESTITURES: BSHSI's 2015 divestiture of a majority interest in Charity Health System (Charity) in New York and the pending full asset sale of Bon Secours New York in 2017, signal the system's willingness to dispose of challenging operations that have historically generated operating losses. BSHSI still retains a 40% interest in Charity. The stronger financial profiles after these divestitures allow the system to focus on its ministry in other key markets.

STRENGTHENED LIQUIDITY: Unrestricted cash and investments have increased significantly since the prior rating review primarily due to the proceeds from the Charity transaction in 2015, along with cash flow from operations. Days cash on hand (DCOH) of 168.7 and cushion ratio of 19x are now more in line with the 215.5 days and 19.4x medians, respectively, for the 'A' rating category. The pending full asset sale of Bon Secours New York is expected to further improve liquidity.

STEADY OPERATING RESULTS: The system continues to generate a consistent operating level with adequate margins for the 'A' rating. Operating EBITDA margins have averaged 8.6% in the past four fiscal years. BSHSI's EBITDA margin (7.9% in fiscal 2016) has historically trailed the category 'A' median (12.6%) due to non-operating losses that include donations and support to community services among other items.

COMPETITIVE MARKETS: Although BSHSI operates in different regions and generally good markets, its operations are heavily concentrated in Virginia. The two Virginia markets, Richmond and Hampton Roads account for approximately 65.1% of total system revenues and 88.8% of operating income. Additionally, the system faces significant competition from other providers in each of its markets.

FOCUSED, WELL-ARTICULATED STRATEGY: BSHSI's strategy in these competitive markets is to redesign primary care access points, expand wellness programs, embrace the opportunity to optimize real-time information from its integrated information technology platform (in acute and post-acute settings), and form regional ACOs and clinically integrated networks (CINs) to partner with other providers in its markets.

RATING SENSITIVITIES

IMPROVING BALANCE SHEET: Fitch expects Bon Secours Health System, Inc. (BSHSI) to sustain a relatively stable level of operations, but an improved balance sheet with the continued disposition of financially challenged operations combined with a moderating debt profile. Improved balance sheet metrics combined with a material and sustained improvement in cash flow may provide upward rating momentum over the longer term.

CREDIT PROFILE

BSHSI, headquartered in Marriottsville, MD, is a Catholic health system with facilities is six eastern states: Maryland, Virginia, Kentucky, South Carolina, Florida and New York. It operates 19 hospitals (12 owned and seven joint-ventured) as well as other non-acute entities, including a number of nursing homes, assisted living facilities, senior housing and home care providers.

Total revenues for the system in fiscal 2016 (ended August 31) were $3.2 billion. The obligated group accounted for approximately 93.9% and 96.2% of BSHSI's revenues and total assets, respectively, in fiscal 2016. The New York operations are not in the Obligated Group. Fitch reports on the performance of the consolidated BSHSI system.

Improved Liquidity from Divestitures

In May 2015, BSHSI disposed of a majority of its ownership of Charity, which had a long-trend of operating losses. A newly created affiliate of Westchester Medical Center now holds a 60% controlling interest in Charity, with BSHSI retaining a 40% minority interest. As part of this transaction, Charity closed on a new bond issuance and used most of the proceeds to repay BSHSI $120 million for a portion of outstanding intercompany loans made by BSHSI to Charity.

The Charity transaction contributed to the system's enhanced liquidity position since 2014. Cash-to-debt increased to a strong 149.3% in fiscal 2016. BSHSI had $1.39 billion in unrestricted cash and investments at fiscal year-end 2016 (August 31), equating to 168.7 days DCOH from $1.14 billion in fiscal 2014 (129.8 DCOH). DCOH growth in fiscal 2016 is also partly attributed to a reduced expense base with the removal of Charity's operations from the consolidated audit.

BSHSI's minority interest in Charity is now accounted for under the equity method. Consequently, non-operating losses were higher in 2016 as the system reported a $5.5 million loss related to its equity portion of its investment in Charity as compared to a $6.9 million business combination gain in 2015 related to the acquisition of Rappahannock General Hospital in that year.

In March 2016, the system also announced a planned full asset sale of Bon Secours New York to a private company that holds over 100 skilled nursing facilities. Bon Secours New York accounts for a modest 1.5% of system revenues, but it has historically generated operating losses. BSHSI does not have a significant presence or network in New York to make these senior care operations viable, which led to the decision to sell to another skilled nursing provider.

The pending sale requires state and church approvals and is projected to close within the next 12 months. The sale is expected to be accretive to the system's liquidity position after repayment of related debt.

Competitive Markets

BSHSI's operations in the Richmond market continue to be the primary driver of the system's profitability. The Hampton Roads market in Virginia (22.4% of system revenues; 1.7% of operating income) is a highly competitive market where competitors have engaged in recent renovations or construction.

Bon Secours St. Francis (21.2% of system revenues; 12.7% of operating income) in South Carolina also operates under significant competitive pressure from its main competitor, Greenville Hospital System. The finncial results from this region were compressed in fiscal 2015 and 2016 from prior years' results and the system is focusing on certain strategies to enhance its relevance in this market. These include enhanced commercial payor relations, new market assessments, the purchase of Doctors Express urgent care centers, and launching a new regional CIN with Spartanburg Regional Health System and AnMed Health. The CIN has submitted an application to qualify as a Medicare Shared Savings Program effective January 2017.

Two of BSHSI's smaller regions, Kentucky (5.9% of system revenues) and Baltimore (3.6% of system revenues) continue to be challenging markets that generated losses in 2016. Although Kentucky has experienced market share and utilization growth, it is a competitive market with limited population growth and challenging Medicaid reimbursement. Baltimore continues to prove difficult as it is a stand-alone hospital with decreasing utilization in a greater market area that is served by several large systems.

Debt Profile

BSHSI had $889 million of debt outstanding as of fiscal-end 2016. Approximately 63% of outstanding debt was issued as fixed debt, but almost all of the system's variable debt is synthetically fixed. Overall, the system has eleven swaps outstanding with six different counterparties.

Maximum Annual Debt Service (MADS) of $73.1 million includes all long-term debt and capital leases. The MADS year is 2020, and MADS decreases to $31.4 million by 2032. BSHSI has adequate MADS coverage of 3.5x for fiscal 2016, slightly below the 4.5x median for the 'A' rating category.

Fitch notes that the system has a growing pension liability, with a 59% funding status as of August 2016. The funding status dropped from 62% in 2015 despite an increase in pension contribution to $51 million due the reduction in discount rate from 4.55% to 3.55%. The system plans to contribute at about this annual level in each of the next five years.

Disclosure

BSHSI covenants to supply both audited annual and unaudited quarterly financial data. Financial disclosure to the market has been timely and includes detailed management discussion and analysis, utilization and operating statistics and consolidating statements.

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

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1015815

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1015815

Endorsement Policy

https://www.fitchratings.com/regulatory

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