Fitch Rates HealthEast, MN's Series 2015 Revs 'BBB-'; Outlook Stable

Fitch Ratings has assigned a 'BBB-' rating to the following Housing and Redevelopment Authority of the City of Saint Paul, Minnesota bonds, issued on behalf of HealthEast Care System (HealthEast):

--$151.3 million hospital facility revenue bonds, series 2015A.

HealthEast will also issue approximately $133.7 million in series 2015B-D taxable variable-rate bonds, to be directly placed with three banks, and are not rated by Fitch.

Together, the series 2015 bonds will be used to fund a portion of capital expenditures, to advance refund the series 2005 bonds, to retire other outstanding debt, to reimburse HealthEast for prior capital expenditures, and to pay costs of issuance. The bonds are expected to price the week of June 8 via negotiation.

In addition, Fitch affirms the following Housing and Redevelopment Authority of the City of Saint Paul, Minnesota bonds at 'BBB-':

--$192.5 million hospital facility revenue bonds, series 2005.

The Rating Outlook is Stable.

SECURITY

The series 2015 bonds are expected to be secured by a security interest in gross receivables of the obligated group and a mortgage on the obligated group's primary hospital facilities. A debt service reserve fund is not expected to be funded, which reflects an erosion in bondholder security from current levels.

KEY RATING DRIVERS

MANAGEABLE DEBT BURDEN: Post-issuance, HealthEast's debt burden will moderate some with a material decline in maximum annual debt service (MADS) to $22.6 million from $37.4 million. Through the six-month period ended Feb. 28, 2015 HealthEast generated 3.0x coverage of pro forma MADS by EBITDA. Further, ongoing capital needs are manageable near $25 million annually, and no additional debt is anticipated over the near term.

LIQUIDITY RECOVERY EXPECTED: As anticipated, HealthEast's liquidity weakened further due to capital outlays related to its electronic health record (EHR) project largely completed in late 2014. As of Feb. 28, 2015, HealthEast had $119.3 million in unrestricted cash and investments, equating to 47.4 days of cash on hand (DCOH) and 5.3x pro forma cushion ratio. Both are well below Fitch's 'BBB' category medians of 145 DCOH and 10.5x cushion ratio, though improvement is expected as cash flow improves and project outlays diminish.

SHORT-TERM PROFITABILITY DECLINE: As expected, HealthEast's operating performance has begun to recover, to a 1.5% operating and 6.8% operating EBITDA margin through Feb. 28, 2015 (including $7.3 million in non-recurring EHR expenses), from a 0.8% operating and 5.6% operating EBITDA margin through fiscal 2014 (including $21.2 million in non-recurring EHR expenses). Further improvement to a 2.5% operating margin is anticipated in fiscal 2015, supported by ongoing strategic initiatives.

COMPETITIVE BUT FAVORABLE MARKET: HealthEast maintains a leading market position in the St. Paul service area, and benefits from the solid socioeconomic characteristics in the area. Inpatient market share was 30.1% in the east metro primary service area as of mid-2014, followed by 28.3% for Allina (rated 'AA-' with a Stable Outlook by Fitch) and 23.6% for HealthPartners.

RATING SENSITIVITIES

IMPROVED LIQUIDITY: Fitch has remained tolerant of HealthEast's relatively weak financial profile for the rating category during its execution of key strategic initiatives. With lower capital spending and improved cash flow, balance sheet metrics are expected to strengthen going forward. Management is projecting to reach 60 DCOH by fiscal 2015 and improved profitability to operating margins above 3% over the longer term. Failure to demonstrate a sustained trend of improvement in profitability and liquidity metrics would likely prompt negative rating pressure.

CREDIT PROFILE

HealthEast is an integrated healthcare system located in St Paul, MN, incorporated in 1986. The system includes three acute care hospitals and a long-term acute care hospital (LTACH) in the St. Paul area, 14 outpatient clinics, over 1,126 medical staff members, and approximately 7,300 employees. St. Joseph's Hospital is located in downtown St. Paul with 239 staffed beds, St. John's Hospital is located in a suburb of St. Paul with 184 staffed beds, and Woodwinds Hospital is located in a suburb of St. Paul with 86 staffed beds. HealthEast also has a long-term acute care hospital, Bethesda Hospital, with 126 staffed beds. The system generated $943.6 million in total revenues in fiscal 2014 (year ended Aug. 31).

Fitch's analysis is based on the consolidated system, which includes all three acute care hospitals, the LTACH, the employed medical group, the HealthEast Foundation, and other controlled affiliates. The obligated group consists of the corporate parent, the three acute care facilities and the LTACH, which together generated 85.2% of total revenues as of Feb 28, 2015.

NEW ISSUE DEBT

HealthEast plans to issue approximately $285 million in series 2015A-D debt including $151.3 million in fixed-rate tax-exempt term bonds and $133.7 million in taxable variable-rate debt directly placed with three banks. The series 2015B-D bonds are expected to be issued simultaneously with the series 2015A bonds, and all will be additionally secured by a mortgage lien. With this issuance, HealthEast will bring the $34 million series 2005-3 A&B Midway Bonds into the obligated group debt structure. This debt is currently held by the Port Authority of the City of Saint Paul, and the Midway facility leased back to HealthEast.

Fitch notes that HealthEast's pro forma debt structure is more aggressive, with approximately 40% uncommitted capital. The earliest renewal date for the bank loans is 2020. The current draft of the bank documents include a semiannual 40 DCOH test that increases to 65 days by FYE 2018, ahead of the 40 DCOH bond indenture requirement. Fitch notes that a failure to meet the DCOH covenant would be an event of default under the bank documents.

Total pro forma long-term debt is estimated at $330.1 million, reflecting no new system debt. Pro forma MADS is estimated at $22.6 million, providing significant debt service relief from the current $37.4 million. Through Feb. 28, 2015, HealthEast generated 3.1x coverage of pro forma MADS by operating EBITDA, and pro forma MADS was equal to 2.3% of total revenue. However, cash-to-pro forma debt was somewhat thin at 36.1%.

Fitch expects HealthEast's leverage to moderate over time as it completes its remaining Epic capital spend by fiscal 2016 and returns to stronger cash flow levels which replenish liquidity. HealthEast does not anticipate further debt issuance over the near- to medium-term, and its average age of plant of 10 years in fiscal 2014 is consistent with the rating category.

DISCLOSURE

HealthEast will covenant to provide annual disclosure within 150 days and quarterly disclosure within 60 days to the Municipal Securities Rulemaking Board's EMMA system. Disclosure includes detailed financial statements, volume statistics, payor mix, an operating and capital budget, and 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/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 30 May 2014)

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

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985620

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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