Fitch Rates Butler Health System (PA) Series 2015A Rev Bonds 'A-'; Outlook Stable

Fitch Ratings has assigned a long-term rating of 'A-' to the expected issuance of approximately $91.2 million of series 2015A hospital revenue bonds through the Butler County Hospital Authority (BCHA) on behalf of Butler Health System (BHS).

In addition, Fitch affirms the 'A-' rating on the outstanding $76 million series 2009B hospital revenue bonds issued by BCHA on behalf of BHS. BHS currently has outstanding $54.5 million in series 2009A and 2010A private placement loans with BB&T, which Fitch does not rate.

The Rating Outlook is Stable.

The planned series 2015A bond proceeds will be used to advance refund the series 2009B and 2010A bonds in full and a portion of series 2009A bonds. In conjunction with this issuance, BHS also plans to issue a $20 million series 2015B variable rate taxable loan (draw down) to fund the construction of a medical office building project and restructure the remaining $41 million series 2009A bonds. The series 2015A bonds are expected to sell the week of Feb. 16, 2015.

SECURITY

The series 2015A bonds will be secured by a pledge of gross revenues and a lien of a mortgage granted by the credit group.

KEY RATING DRIVERS

LEADING MARKET POSITION: BHS continues to maintain a dominant market position, despite operating in a very competitive service area. Inpatient market share in the primary service area was 65.8% in the first three quarters of 2014, up from 63.7% in 2013. However, the Pittsburgh region is expected to experience some commercial insurance shifts this year, creating a level of uncertainty in future volume trends and payor mix.

IMPROVING PROFITABILITY: BHS posted solid profitability metrics in 2014 with operating and operating EBITDA margins of 5.2% and 13%, respectively, which were supported by better mix and higher acuity of services. Strong profitability continued through the five-month interim period ended Nov. 30, 2014, with operating and operating EBITDA margins at 5.2% and 12.8%, respectively.

STEADY LIQUIDITY GROWTH: Unrestricted cash and investments have grown by 35% over the last three years, reflecting sound cash flows and lower capital spending. As capital expenditures rise above depreciation levels in 2015-2016, liquidity growth is expected to slow but maintained at a level consistent with the 'A-' rating.

MANAGEABLE DEBT INCREASE: The planned 2015 transaction will increase long-term debt by $20 million. While debt metrics will likely be pressured, Fitch believes the steady growth in revenues and liquidity in recent years expanded capacity to absorb the new debt at the current rating.

HIGH DEBT BURDEN: Despite new debt, maximum annual debt service (MADS) of approximately $9.3 million is expected to remain unchanged due to interest savings on the refunded bonds. Pro forma MADS represented 3.4% of 2014 revenues, which is somewhat elevated compared to the 'A' category median of 3.1%. However, coverage of pro forma MADS by EBITDA is a sound 3.9x in 2014 and 4x in the 2015 interim period due to BHS's solid profitability.

RATING SENSITIVITIES

CONTINUED STABILITY EXPECTED: In light of BHS's light liquidity metrics , Fitch expects BHS to weather potential regional pressures and continue producing sound cash flows to produce adequate debt service coverage metrics at the 'A-' rating.

CREDIT PROFILE

Located in Butler County, PA, Butler Health System is a 338 licensed-bed (296 acute care, 25 skilled nursing, and 17 nursery) large community hospital system that offers select higher-end services in Western Pennsylvania. In total, BHS has 29 outpatient care sites in its network, including four urgent care clinics. In fiscal year ended June 30, 2014, BHS had approximately $274.8 million in total operating revenue.

Dominant Provider in a Competitive Service Area

BHS continues to maintain steady growth and financial strength despite operating in a fairly competitive area. Management has been successfully executing BHS's strategic plans involving regional outpatient expansion, select physician partnerships, and continued focus on delivering value. Inpatient market share in the primary service area was a strong 65.8% in the first three quarters of 2014 and 63.7% in 2013.

Competition in the greater Pittsburgh area continues to be a concern, and has intensified between two major insurers/integrated delivery networks operating in the region; University of Pittsburgh Medical Center (UPMC; rated 'AA-', Negative Outlook by Fitch) and Highmark/Allegheny Health Network (AHS). Increase in competitive pressure and dispute between UPMC and AHS has created significant friction in the Pittsburgh market, and is expected to cause shifts in the commercial insurance market this year. While the overall impact is uncertain, management expects to continue collaborating with both networks and reports no discernible changes in BHS's volume or payor mix thus far.

Rebounded Profitability

BHS posted unusually strong results in fiscal 2014 due to growth in case-mix index as well as a favorable mix of services. Operating and operating EBITDA margins were a strong 5.2% and 13% in fiscal 2014, respectively, compared to 1.6% and 10% in 2013 and the respective 'A' category medians of 2.5% and 9.5%. Strong profitability continued through the five month interim period ended Nov. 30, 2014 with operating and operating EBITDA margins of 5.2% and 12.8%, ahead of target operating margin of 3.5%.

Adequate Liquidity

At Nov. 30, 2014, unrestricted cash and investments totaled $132.5 million, equating to 188 days cash on hand and 101.6% cash to debt, which reflect a steady improvement over the last five years. Following the 2015 transaction, cushion ratio will remain relatively unchanged at 14.3x but cash to debt will decline to 87%, which are weak but mitigated by BHS's strong profitability generation.

DEBT PROFILE

Fitch has historically cited BHS's relatively high debt burden as a key credit concern, but believes the recent growth in balance sheet and revenue base of the organization offsets the $20 million planned increase in debt. Additionally, projected pro forma MADS of $9.3 million is essentially unchanged due to interest savings expected on the refunded bonds.

The 2015 financing will effectively restructure all of BHS's outstanding bonds, with all currently outstanding bonds being refunded or restructured. Pro forma long-term debt is expected to total $152.2 million, consisting of series 2015A, 2015B, and 2009A (restructured) bonds. Approximately 60% of debt will be fixed rate, which is consistent with prior levels. BHS does not have any swaps outstanding.

Pro forma, debt to capitalization is expected to increase to 50.3% from 41.9% at Nov. 30, 2014 which is high relative to the 'A' median of 36.3%. Pro forma MADS equates to 3.4% of fiscal 2014 revenues which BHS covered by EBITDA at 3.9x in fiscal 2014 and 4.0x through the five month interim period ended Nov. 30, 2014.

DISCLOSURE

BHS has covenanted to provide financial information to DAC. Quarterly information consists of financial statements and select utilization data.

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

Applicable Criteria and Related Research:

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

--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria' (May 30, 2014).

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=978920

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