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Fitch Assigns a 'AA-' to Mercy Health 2018A Taxable Bds; 'F1+' to 2018A&B Taxable CP; Outlook Stable.

New York: Fitch Ratings has affirmed its 'AA-' Issuer Default Rating (IDR) for Mercy Health and has assigned a 'AA-' rating to the following series of bonds to be issued by Mercy Health, OH.

--$300 million taxable bonds series 2018A.

Fitch also assigns its 'F1+' short-term rating to the 2018A and 2018B CP backed by Mercy Health self-liquidity.

Simultaneously, Fitch affirms at 'AA-' bonds issued by Mercy Health (OH) or on behalf of Mercy Health by Allen County (listed at the end of the release) and affirms its 'F1'+ on the Allen County (OH) series 2012B backed by Mercy Health self-liquidity.

The Rating Outlook on all bonds is Stable.

Proceeds from the 2018A bonds will be used to refund certain debt issued on behalf of Bon Secours Health Care System, Inc., MD (BSHSI), which completed a business combination on Sept. 1, 2018. As part of that transaction, BSHSI, now known as Bon Secours Mercy Health, Inc. (BSMH), was substituted as the sole corporate member of Mercy Health. In response, Fitch is assigning an 'AA-' IDR to Bon Secours Mercy Health (BSMH) and placing on Rating Watch Positive the IDR and bonds issued by various issuers on behalf of BSHSI (listed at the end of the release) as BSHSI debt that is not refunded will be substituted with security under Mercy Health's security structure at the time of the closing, and therefore expected to be upgraded to Mercy Health's 'AA-' IDR and revenue bond ratings.

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At a future date, anticipated on or about Jan. 1, 2020, Mercy Health will be merged into BSMH, with BSMH as the surviving entity. Fitch analysis is based on the consolidated pro forma financial results of the combined BSMH organization.

The 2018 Transactions Summary

Mercy Health will be issuing approximately $300 million in series 2018A taxable fixed rate debt and $100 million taxable CP backed by self-liquidity. Additionally, Mercy Health plans to issue $310 million in direct private placement with two banks, for which the banks did not require a Fitch rating. Proceeds from the 2018 transactions will be used to refund all of the outstanding BSHSI debt with the exception $110 million of BSHI tax-exempt series 2013B and series 2017 (which are currently directly placed with Bank of America Merrill Lynch and not rated by Fitch) for which security will be substituted with Master Obligations issued under the Mercy Health Supplemental Master Trust Indenture Number Two (2018 MTI) dated Dec. 1, 2018, supplementing the 2017 Amended and Restated Mercy Health MTI (2017 MTI). The 2018 transaction does not include any new money. The transaction is expected to be priced the first week in December via negotiation.

The taxable series 2018A and 2018B will have a bullet maturity in 2028, and the CP, which is backed by self-liquidity, has a 30 year final maturity. The bank placements have five and eight year terms. Maximum annual debt service (MADS) of approximately $191 million, provided by the underwriters, occurs in 2031 and is based on smoothing of debt service as permitted by the MTI.

SECURITY

General obligation of Mercy Health under the Supplemental Master Trust Indenture Number Two dated Dec. 1, 2018 supplementing the 2017 Amended and Restated Mercy Health Master Trust Indenture. Mercy Health will exercise its rights under the 2018 MTI to require its affiliates, and selected BSHSI contractual affiliates that comprised a significant majority of the revenues of the legacy BSHSI organization, to upstream funds to Mercy Health to satisfy obligations issued under the 2018 MTI.

ANALYTICAL CONCLUSION

The 'AA-' IDR for BSMH and the affirmation of the 'AA-' rating for Mercy Health and Stable Outlook reflect the combined organization's broad geographic footprint as one of the largest Catholic systems in the country with a good payor mix, leading market share position in several of its markets, and a strong financial profile consistent with the 'AA-' rating. Fitch's rating case shows resiliency through the stressed rating case scenario with the combined system improving to 132% cash to adjusted debt by year four and net adjusted debt to adjusted EBITDA in a negative position through the entire forward cycle (negative 1.0x in year four).

KEY RATING DRIVERS

Revenue Defensibility: 'bbb'; Favorable Revenue Mix and Leading Market Share in Several Markets

The midrange revenue defensibility is supported by the combined entity's favorable revenue mix with Medicaid and self-pay at 24%, significant geographic diversity across seven states with no overlap of the markets served by the newly formed organization, solid presence in some markets and several markets where it is the market leader.

Operating Risk: 'a'; Strong Operating Profitability and Manageable Capital Needs

The combined operating results of the merged organization, based on unaudited numbers, have been strong with operating EBITDA margin averaging 9.5% and EBITDA of 11.7% for the last two years. Capital expenditures are viewed as manageable and projected at approximately 115% of depreciation expenses.

Financial Profile: 'aa'; Resiliency Through the Forward Cycle

The combined profile of the merged organization presents good recovery from the rating case stress with liquidity and leverage assessed at Fitch's strong 'aa' and consistent with the 'AA-' rating based on adjusted debt to adjusted EBITDA at negative 1.0x in year four of the forward cycle and cash to adjusted debt at 132%.

Asymmetric Additional Risk Considerations

No asymmetric risk factors were applied in this rating determination.

RATING SENSITIVITIES

Maintenance of Strong Financial Profile: Fitch expects the combined organization to maintain a profile of sustained operating profitability supporting solid liquidity position and manageable leverage based on an integration strategy focused on implementing system wide synergies and resulting in increased operating efficiencies. Weakened profitability, while not expected, could results in negative rating pressure.

CREDIT PROFILE

On Sept. 1, 2018, Bon Secours Health System, Inc. (BHSHI; A/Stable) and Mercy Health (AA-/Stable) completed the combination of the two healthcare organizations and BSHSI changed its name to Bon Secours Mercy Health, Inc. (BSMH). As part of that transaction, BSMH was substituted as the sole corporate member of Mercy Health. It is anticipated that at about Jan. 1, 2020, Mercy Health will be merged into BSMH and BSMH will, as the surviving entity, be the obligor on all debt issued under the Mercy Health MTI. The Board of Directors of the new BSMH is, with only minor exceptions, the same as that of Mercy Health.

BSMH, following the combination of the two legacy organizations, became one of the largest Catholic healthcare systems in the United States. The system operates 42 hospitals and other health care services in seven states: Florida, Kentucky, Maryland, New York, Ohio, South Carolina and Virginia with more than 7,900 licensed beds and employs approximately 2,100 physicians and provides care at over 1,000 sites. Effective Nov. 14, 2018, Mercy Health and the Ohio State University Wexner Medical Center in Columbus, OH (Wexner), formed the Healthy State Alliance (Alliance). The Alliance will combine the Mercy Health access points across Ohio with the clinical strengths of Wexner, a major academic medical center with 1,380 beds, with focus on transplants, treatment of cancer and addressing the opioid crisis.

Based on the Mercy Health Dec. 31, 2017 audited financial statements and the BSHSI Aug. 31, 2018 audited financial statements, the combined system reported revenues of $8.0 billion, assets of $10.3 billion and combined cash and unrestricted investments of approximately $3.9 billion (unaudited). Fitch reports on the results of the combined system.

The coming together of the two systems was facilitated by commonality of their missions and values. The integration was unusually fast and seamless with the new 14 member senior executive management team in place effective the merger date and composed equally from members of the two legacy organizations. BSMH is headed by John Starcher, the President and CEO, who served in that capacity at Mercy Health.

Revenue Defensibility

BSMH has a favorable payor mix with combined Medicaid and self-pay accounting for 24% of gross patient revenues as Sept. 30, 2018. Medicare accounts for approximately 49% of gross revenues and commercial and managed care contracts for an additional 26%. However, Medicare and Medicaid accounting for an aggregate 70% of gross revenues exposes the system to potential risks of federal and state budget cuts.

The result of the merger resulted in an organization with a significant degree of geographic dispersion over seven states and presence in several markets where it has either a solid presence, or in several markets where it is the market leader. Significantly, there was essentially no overlap in the markets served by the two legacy organizations resulting in absence of antitrust issues. Following the merger, the facilities were grouped into three divisions each headed by a member of the senior management team: Atlantic Division (New York, Maryland, Virginia, South Carolina and Florida), Great Lakes Division (Lima, Toledo, Lorain and Youngstown in Ohio) and Mid-America Division (Cincinnati, Springfield and Urbana in Ohio and Ashland, Paducah, and Irvine in Kentucky).

The Atlantic Division, which includes the legacy BSHSI hospitals, is heavily concentrated in three markets - the greater Richmond metro area and Hampton Roads in Virginia, and Greenville in South Carolina. The Richmond metropolitan area and Greenville are both competitive but growing markets in which the system has the second market share position and plans to invest capital to support further growth. The main competitors are HCA in the Richmond market and Greenville Hospital (AA-/Stable) in Greenville. The Hampton Roads market is a fiercely competitive area with Sentara the main competitor and has historically been a challenge and will be a major focus of the new management in order to improve efficiency and increase recruitment.

The combined Great Lakes and Mid-America Divisions hold a leading 12% statewide market share in Ohio and leading market shares in five of its seven regional markets including Cincinnati, and dominant market share of better than mid 50% share in three of those - Springfield, Youngstown and Lima. The system holds the number two market share in the remaining two regional markets - Toledo and Lorain. Primary competitors vary by market but include ProMedica, Cleveland Clinic, UHHS, Premier and Ohio State University. The strong market position is reflected in across the board volume growth, with the exception of emergency room visits, which have been intentionally reduced as lower acuity services have been shifted to urgent care centers and other outpatient facilities.

Given the broad geographic footprint of the BSMH facilities, there is no dependence on any particular market demographics and the service areas have mixed demographic profiles. However, there are several markets that exhibit good population growth and favorable demographic metrics, such as Richmond, VA and Cincinnati, OH, while some have weaker profiles, such as Toledo and Youngstown, OH.

Operating Risk

The financial results for the two legacy organization have been consolidated for two years - 2016 and 2017 (year-end Dec. 31, unaudited) and for the two interim periods ended Sept. 30 2017 and 2018. Mercy Health has a Dec. 31 fiscal year and BSHSI has an Aug. 31 fiscal year-end. The combined entity will transition to Dec. 31 starting with this year.

On a combined basis, BSMH generated operating EBITDA margins of 8.8% and 10.2%, respectively in 2016 and 2017 and 10.2% through the nine months ended Sept. 30, 2018. EBITDA margins were equally strong with 9.8% in 2016, 13.7% in 2017 and were maintained at 11.2% though Sept. 30, 2018. Very shortly following the consolidation of the two systems, the new management team formulated a detailed plan with sharply delineated responsibilities intended to drive efficiencies through the organization. The combination of the two organizations has facilitated realization of a number of synergies for share services expected to result in savings projected at approximately $280 million by 2021. The major opportunities anticipated to yield savings in order of scale are centralization of supply chain, revenue cycle management, IT (both are on Epic platforms), pharmacy as well as majority of back office functions.

An outside firm (Hammes Company) has been engaged to make an assessment of capex needs of the combined organization in the context of the different markets being served. Both legacy organizations have average life of plant of around 13 years and have not at this time identified any specific major capital projects. The assumption of capital investment of approximately $500 million-$575 million annually, which Fitch views as manageable at roughly equal to 115% of depreciation expenses, places BSMH in Fitch's 'bbb' assessment of high capital needs. Both organizations have invested in EPIC electronic medical platforms and the system will eventually move to a single data center.

Financial Profile

A pro forma combination of BSHSI and Mercy Health shows cash and unrestricted investments at $3.9 billion at Dec. 31, 2017 (unaudited), placing cash to adjusted debt at 111% and net adjusted debt to adjusted EBITDA at negative 0.3x. At Sept. 30, 2018 the combined liquidity position was reported at $4 billion. No pension expense is added to adjusted debt as the two organizations' defined benefit pension plans on a combined basis are funded in excess of 80%. Fitch's adjusted debt of $3.5 billion in 2017 adds $513 million to debt as a 5x multiple of the aggregate operation lease expense.

Fitch's base case assumes revenue growth at a relatively moderate rate of around 3.0% to 3.5%, which combines the slightly higher historical revenue growth of Mercy Health with the somewhat slower overall growth of BSHSI. Capital spending is assumed at about to 115% of depreciation expense over the next five years ranging from between approximately $480 million to $575 million. No additional debt is anticipated in the near term. A total of $56 million is available from dedicated bond proceeds to fund a portion of the capital needs in 2019.

Fitch applies the standard revenue stress to the rating case, which reduces revenues by 2% in the first year (2019), 1% in the second year and then increases revenues by 1% in year three over the base case. Standard stress is also applied to the investment portfolio; the 10.4% decline reflects moderately aggressive asset composition, which includes 8% cash, 30% fixed income, 35% equities and 27% hedge funds and other alternative investments. Fitch reduces capital spending during the period of the applied stress by approximately 20% in years two and three to reflect management's likely response to the scenario's compressed cash flows.

BSMH's financial profile demonstrates resiliency with gradual improvement through Fitch's rating case scenario, which supports the 'AA-' rating. Cash to adjusted debt improves to 132% by year four of the rating case and net adjusted debt to adjusted EBITDA is maintained at a negative position during the entire forward cycle and is at negative 1.0x in year four.

Asymmetric Additional Risk Considerations

No asymmetric risk factors were applied in this rating determination.

As part of the merging of the two predecessor organizations, all BHSI outstanding debt will be either refunded or transferred under the Mercy Health security structure. The plan of finance includes: $110 million of BSHI series 2013B and series 2017 tax-exempt debt (which is currently directly placed with Bank of America Merrill Lynch and not rated by Fitch) will substitute existing BSHSI Master Obligation with Master Notes issued under the Mercy Health MTI. Approximately $300 million of 10-year taxable debt, $100 million of taxable CP and $310 million issued as direct bank placements will be issued under the Mercy Health MTI and proceeds will be used to defease the remaining legacy BSHSI debt. The 2018 transaction does not include any new money borrowing.

The 'F1+' rating reflects Mercy Health's long-term rating and credit quality, as well as its cash and investment. At Oct. 31, 2018, Mercy Health's eligible cash and investment position under Fitch's criteria would cover the cost of the maximum mandatory put on any given date in excess of Fitch's 1.25x threshold for the 'F1+' short-term rating. Over $790 million of Mercy Health's unrestricted liquidity can be liquidated within three days to support the system's $200 million of self-liquidity debt including the $100 million in the current transaction.

The pro forma debt of the combined system, including current portion, was approximately $2.9 billion at Sept. 30, 2018. Post transaction the debt composition is expected to be 58% fixed and 42% variable. BSMH has eight swaps outstanding with approximately $919 million notional par, which had mark to market of approximately negative $54.2 million at Oct. 31, 2018. Five of the swaps are legacy BSHSI swaps which are secured with master notes under the BSHSI master trust indenture. Those are expected to be novated later this year and become obligations under Mercy Health's ISDA Master Agreement, but will not be secured by master notes.

Mercy Health (OH)

Allen County (OH) (Catholic Healthcare Partners) adj-rate hosp facils rev bonds ser 2010C (LOC: MUFG Union Bank, National Association)

Allen County (OH) (Catholic Healthcare Partners) adj-rate hosp facils rev bonds ser 2012B

Allen County (OH) (Catholic Healthcare Partners) hosp facils rev bonds ser 2010A

Allen County (OH) (Catholic Healthcare Partners) hosp facils rev bonds ser 2010B

Allen County (OH) (Catholic Healthcare Partners) hosp facils rev bonds ser 2012C

Allen County (OH) (Catholic Healthcare Partners) hosp facils rev rfdg & improv bonds ser 2012A

Allen County (OH) (Mercy Health) adj-rate hosp facils rev bonds ser 2015B

Allen County (OH) (Mercy Health) adj-rate hosp facils rev bonds ser 2017B

Allen County (OH) (Mercy Health) hosp facils rev rfdg & improv bonds ser 2015A

Allen County (OH) (Mercy Health) hosp facils rev rfdg & improv bonds ser 2017A

Mercy Health (OH) bonds (taxable) ser 2017C

Mercy Health (OH) taxable bonds ser 2015C

Mercy Health (OH) / Short-Term Rating

Allen County (OH) (Catholic Healthcare Partners) adj-rate hosp facils rev bonds ser 2012B

Bon Secours Health Care System (MD)

Chesterfield County Economic Development Authority (VA) (Bon Secours Health System, Inc.) rev bonds ser 2008C-1

Chesterfield County Economic Development Authority (VA) (Bon Secours Health System, Inc.) rev bonds ser 2008C-2

Hanover County Economic Development Authority (VA) (Bon Secours Health System, Inc) rev rfdg bonds ser 2008D-1 (bank bnds)

Hanover County Economic Development Authority (VA) (Bon Secours Health System, Inc) rev rfdg bonds ser 2008D-2 (bank bnds)

Henrico County (VA) (Bon Secours Health System, Inc.) health care rev bonds ser 1992B

Henrico County (VA) (Bon Secours Health System, Inc.) health care rev bonds ser 1992C

Henrico County (VA) (Bon Secours Health System, Inc.) hosp rev rfdg bonds ser 1996

Henrico County Economic Development Authority (VA) (Bon Secours Health System, Inc.) rev bonds ser 2008B-1

Henrico County Economic Development Authority (VA) (Bon Secours Health System, Inc.) rev bonds ser 2008B-2

Henrico County Economic Development Authority (VA) (Bon Secours Health System, Inc.) rev bonds ser 2013

Norfolk Economic Development Authority (VA) (Bon Secours Health System, Inc) rev bonds ser 2013

Norfolk Economic Development Authority (VA) (Bon Secours Health System, Inc.) rev rfdg bonds ser 2008D-1 (bank bnds)

Norfolk Economic Development Authority (VA) (Bon Secours Health System, Inc.) rev rfdg bonds ser 2008D-2 (bank bnds)

Russell (KY) (Bon Secours Health System, Inc.) rev bonds ser 2013

South Carolina Jobs-Economic Development Authority (SC) (Bon Secours Health System, Inc.) econ dev rev rfdg bonds ser 2008D (bank bnds)

South Carolina Jobs-Economic Development Authority (SC) (Bon Secours Health System, Inc.) econ devel rev bonds ser 2013
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Publication:Daily the Pak Banker (Lahore, Pakistan)
Geographic Code:1U3OH
Date:Jan 25, 2019
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