[January 15, 2013]

Fitch Revises Essentia Health's (MN) Outlook to Stable; Affirms 'A-'Revs

Fitch Ratings has affirmed the 'A-' rating on in the following outstanding revenue bonds issued on behalf of Essentia Health (Essentia).

--$9.6 million Minnesota Agricultural & Economic Development Board health care facilities revenue bonds, series 1999A

--$1.1 million Duluth Economic Development Authority health care facilities revenue bonds, series 2004

--$61.1 million Cass County health care facilities variable-rate demand revenue bonds, series 2008A

--$46.0 million Cass County health care facilities revenue bonds, series 2008D

--$42.0 million Minnesota Agricultural & Economic Development Board health care facilities revenue bonds, series 2008E

--$154.0 million Minnesota Agricultural & Economic Development Board health care facilities variable-rate demand revenue bonds, series 2008C

--$12.9 million Wisconsin Health & Educational Facilities Authority health care facilities variable-rate demand revenue bonds, series 2008B

Essentia has an additional $129 million in direct placement debt and $6 million in non-obligated group debt which Fitch does not rate. The series 2008A, 2008B and 2008C bonds were reoffered as fixed rate in 2010.

Fitch has also revised Essentia Health's Rating Outlook to Stable from Positive.

SECURITY

The bonds are a joint and several obligation of the obligated group. The bonds are secured by a pledge of unrestricted receivables, subject to permitted encumbrances and a debt service reserve fund.

KEY RATING DRIVERS

ADDITIONAL DEBT EXPECTED: The outlook revision to Stable from Positive is due to Essentia's plans to issue $100 million of additional debt in 2013 and weaker operating performance in fiscal 2012. Fitch did not anticipate either of these developments at the time of its last review (when Fitch assigned the Positive Outlook).

DEBT LEVEL REMAINS MANAGEABLE: Essentia plans to issue $192.9 million of nonrated fixed-rate bonds in first quarter-2013, including $50 million in new debt to be used for capital plans and strategic growth. Fitch also expects Essentia to issue another $50 million later this year for strategic capital uses. Essentia's pro forma debt burden is manageable for the current rating level. Pro forma debt to EBITDA coverage was 3.7x and MADS coverage EBITDA was 3.7x through the three-month interim period.

STEADY OPERATING PERFORMANCE: Despite a decline in fiscal 2012, Essentia has maintained solid operating performance. Essentia produced a 2.5% operating and 8.6% operating EBITDA margin through the three-month interim period ended Sept. 30, 2012.

STRONG CLINICAL INTEGRATION: Fitch believes Essentia's long-standing alignment with a large medical staff coupled with successful deployment of its EPIC information technology platform should result in improved care management, clinical efficiency, and better quality. All of these are key to success under healthcare reform.

GROWING MARKET PRESENCE: Essentia has expanded its market reach via selective partnerships with area hospitals and clinic integration. This has supported steady utilization, consistent revenue growth, and allows Essentia to negotiate its payor contracts from a position of strength. That said, Fitch notes that Essentia faces material competition in certain markets from several hospital systems.

MODEST BALANCE SHEET: While Essentia's total unrestricted liquidity has consistetly grown to $512.3 million at Sept. 30, 2012 its associated ratios remain light for the 'A' rating category. At Sept. 30, 2012 Essentia had 128.6 days of cash on hand (DCOH), 99.8% cash to debt (which drops to 82.6% post-issuance), and 11.4X pro forma cushion ratio. All of these figures fall below Fitch's 'A' category median ratios of 191 DCOH, 116.4% cash to debt, and 16.3x cushion ratio.

CREDIT PROFILE

Essentia's 'A-' affirmation reflects the system's increasing yet manageable debt level, steady operating performance, growing market presence, high level of clinical integration and reform preparedness, and relatively light (albeit improving) liquidity metrics.

Proceeds from the $192.9 million series 2013 issuance will be used to refund Essentia's $6.3 million in series 1999 bonds, $7.1 million series 2008 Brainerd (News - Alert) debt, $101.3 million series 2010 direct placement debt, and $25.1 million series 2011 private placement. Additionally, $50 million will be used to reimburse prior and fund future capital expenditures. Essentia also has preliminary plans to issue an additional $50 million in direct placement debt later this year.

Post both debt issuances, Essentia will have approximately $620 million in total long term debt (of which $50 million will be variable-rate). Total pro forma MADS equals $44.9 million. This includes $36.1 million in obligated group debt and capital lease payments, $2.3 million in non-obligated debt requirements, $400,000 in guarantees, and $3.8 million which assumes the full draw on a $60 million line of credit per the definition of MADS in Essentia's Master Trust Indenture. As of Jan. 15 2013, there was nothing drawn on the line of credit.

Essentia will also terminate $52 million in fixed payor swaps, leaving approximately $51 million in fixed payor swaps outstanding. Upon this restructuring, the swaps will have a $20 million collateral posting threshold, and no collateral is currently being posted.

Bond proceeds will be used in part on capital expenditures, which may include a sizeable renovation/expansion of its Fargo facility. Fitch believes this is a necessary strategy to grow its market position within this high-growth service area against sizeable competition from Sanford Health. Essentia maintains leading market position within the East Region (Duluth/north Wisconsin) and its overall market reach continues to grow. That said, Essentia faces significant competition within its West Region (North Dakota/northwest Minnesota) and Central Region (central Minnesota).

A key credit strength remains Essentia's large base of 686 employed/799 active medical staff. Fitch believes its large base will allow Essentia to continue implementing more efficient and effective care management practices across its care sites. This is expected to translate into better outcomes, cost management, and should help support favorable reimbursement from both government and commercial payors.

The Stable Outlook reflects the short term impact that additional debt will have on Essentia's financial profile, and Fitch's expectation that Essentia's capital plans could hinder meaningful growth in liquidity over the near term. However, Fitch believes that positive rating movement could occur over the next one to two years if Essentia can generate cash flow at levels which result in balance sheet growth to levels more reflective of Fitch's 'A' category medians.

Essentia is an integrated health care system with acute hospitals and physician clinics spread throughout Northern Minnesota, Eastern North Dakota, and Northwest Wisconsin. Its operations include 16 hospitals and 65 clinics across the region, and nearly 800 physicians.

Essentia's total revenue in fiscal 2012 was approximately $1.6 billion. Essentia covenants to provide quarterly unaudited consolidated financial statements within 60 days of quarter end and annual audited financial statements and operating data with 120 days to the Municipal Securities Rulemaking Board's EMMA system. Disclosure to Fitch has been timely and thorough, with good access to management.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 12, 2012);

--'Nonprofit Hospitals and Health Systems Rating Criteria' (July 23, 2012).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm rpt_id=681015

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm rpt_id=683418

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