[April 04, 2014]

Fitch Affirms Hospital Sisters Services, Inc. (IL) Revs at 'AA-/ F1+'; Outlook Stable

Fitch Ratings has affirmed the 'AA-' long-term ratings on the following revenue bonds issued on behalf of Hospital Sisters Services, Inc. (HSSI):

--$76.9 million Wisconsin Health and Educational Facilities Authority, series 2012B;

--$68.8 million Illinois Finance Authority, series 2012C;

--$61.1 million Wisconsin Health and Educational Facilities Authority, series 2012D*;

--$41.6 million Wisconsin Health and Educational Facilities Authority, series 2012E*;

--$31.6 million Illinois Finance Authority, series 2012F*;

--$31.6 million Illinois Finance Authority, series 2012G*;

--$72.0 million Illinois Finance Authority, series 2007A.

*Underlying rating. The bonds are expected to be supported by an irrevocable direct pay letter of credit issued by the Bank of Montreal, N.A.

In addition, Fitch has affirmed the 'AA-/F1+' ratings to the following variable-rate demand revenue bonds issued on behalf of HSSI. The 'F1+' is based on the sufficiency of the self-liquidity provided by HSSI:

--$65.9 million Illinois Finance Authority, series 2012H;

--$89.5 million Illinois Finance Authority, series 2012I;

--$14.2 million Wisconsin Health and Educational Facilities Authority, series 2012J.

The Rating Outlook is Stable.

SECURITY: Joint and severable liability of each member of the obligated group

KEY RATING DRIVERS

STRONG LIQUIDITY POSITION: HSSI's robust liquidity position provides a strong financial cushion which mitigates the system's light but improving operating profitability and the risks associated with its variable-rate debt exposure.

SOLID DEBT SERVICE COVERAGE: HSSI's light debt burden allows for solid coverage of maximum annual debt service (MADS) despite modest profitability. Coverage of MADS by EBITDA was very solid 6.6x and 6.3x in fiscal 2012 and 2013, respectively. Moreover, MADS coverage by operating EBITDA of 4.1x and 4.5x in fiscal 2012 and 2013 is much improved from fiscal 2010 and 2011.

IMPROVED OPERATING PERFORMANCE: HSSI's operating profitability has improved sharply since fiscal 2011 despite continued investment in its physician alignment strategy. Operating EBITDA margins improved to 7.7% and 8.1% in fiscal 2012 and 2013 from 4.4% in fiscal 2011. Operating improvement at HSSI's flagship, St John's Hospital in Springfield, IL has been key with further improvement expected in 2014.

CHALLENGING SERVICE AREAS: HSSI's location in mid-sized markets with stagnant growth, the concentration of system revenue at St. John's (the flagship hospital in Springfield), and its reliance on its five Wisconsin hospitals to cover losses at its Illinois facilities continue to be credit concerns.

AMPLE INTERNAL LIQUIDITY: HSSI maintains ample cash and investments which can be liquidated to fund any failed remarketing on approximately $169.5 million variable-rate demand bonds exceeding Fitch's criteria for assignment of an 'F1+' short-term rating.

RATING SENSITIVITIES

IMPROVED OPERATING PERFORMANCE: HSSI's improvement in operating performance combined with its strong liquidity position and light leverage provide ample financial cushion to absorb the corporation's continued physician alignment strategy as well as the transition to value based reimbursement models at the current rating level.

CREDIT PROFILE

HSSI is composed of 13 inpatient hospitals, with eight facilities in Illinois and five facilities in Wisconsin. In fiscal 2013, the system had 1,965 beds in operation and total revenue of $2 billion.

Fitch's analysis is based upon consolidated financial statements. In 2013, the obligated group accounted for 93.2% of consolidated operating revenue and 90.0% of consolidated total assets in fiscal 2013.

STRONG LIQUIDITY / LIGHT DEBT BURDEN

The 'AA-' rating reflects the benefits of HSSI's robust balanc sheet, light debt burden and solid debt service coverage which serve to mitigate HSSI's historically weak operating profitability for the rating category. At Dec. 31, 2013, HSSI's unrestricted cash and investments totaled $1.71 billion which is up from $1.63 billion at fiscal year-end (FYE) 2013 (+4.9% increase) and $1.47 billion at FYE 2012 (+16.6% increase). HSSI's days cash on hand, cushion and cash-to-debt ratios of 324.7, 47.4x and 265.6%, respectively, well exceed the 'AA' category medians.

HSSI enjoys a light debt burden which allows for strong debt service coverage despite light but improving profitability. MADS of $36 million equates to a light 1.8% of fiscal 2013 total revenues while debt to capitalization (at Dec. 31, 2013) of 21.4% compares favorably to the 'AA' category median of 32.7%. Coverage of MADS by EBITDA has been very solid at 6.6x and 6.3x in fiscal 2012 and 2013, respectively, and exceeds the 'AA' median of 5.0x. Coverage of MADS by operating EBITDA has improved to 4.1x and 4.5x in fiscal 2012 and 2013 and is now in line with the 'AA' category median. Further capital spending has been strong averaging 164% of depreciation expense over the last three years.

LIGHT BUT IMPROVING PROFITABILITY

Since posting a $44.8 million loss from operations (-2.4% operating margin) in fiscal 2011, HSSI has generated improved profitability in fiscal 2012 and 2013. In fiscal 2012, HSSI generated 'break even' operations and in fiscal 2013, the corporation generated income from operations of $18.8 million (0.9% operating margin). However, Fitch notes that 2013 results were enhanced by receipt of 'EHR Incentive Program' revenues in 2013 ($31.8 million in 2013 vs. $4.2 million in 2012). The improved results of the system's hospital operations have been diluted by the losses from HSSI's physician alignment and employment strategy. Operating performance through the six month interim period ended Dec. 31, 2013 is improved over the prior year period with $12.8 million of income from operations (1.2% operating margin) compared to $9.5 million in operating income (1% operating margin) in prior year period.

At FYE 2013, the system employed a total 588 physicians and mid-level providers as compared to 431 at FYE 2010. Along with the acquisition of established physician practices, HSSI has many newly recruited physicians, which continues to have a negative impact on profitability. Growth in the employed physician group is expected to continue over the near to medium term which will likely depress the rate of profitability improvement.

SERVICE AREA CHALLENGES:

Many of HSSI's hospitals are located in mid-sized markets with little projected population growth and marginal demographics. Management is making progress in reducing losses at St. John's-Springfield, which accounted for about 22% of total system revenues in fiscal 2013 which is viewed positively. The operating loss at St. John's- Springfield narrowed to roughly $11 million in fiscal 2013 from $20.9 million in 2012 and $34.4 million in 2011. Proceeds from the series 2012 financing are being used to rebuild the surgical suites and remodel of four patient floors, which should improve surgical volumes and further improve the financial performance at St. John's. Fitch believes improved financial performance at St. John's is critical to the overall operating success of the system. Fitch expects to see improved operating balance across the system as capital improvements and physician alignment strategies take hold.

SELF LIQUIDITY

The 'F1+' short-term rating reflects the sufficiency of HSSI's highly liquid cash and investments available to fund any failed re-marketing puts on approximately $169.5 million of series 2012 variable-rate demand bonds. At Feb. 28, 2014, after assigning appropriate discounts based on underlying ratings and maturity of its holdings, HSSI had eligible cash and fixed income investments available to fund any un-remarketed puts well in excess of the required threshold of 1.25x to achieve the 'F1+' short-term rating. The system has a written procedures letter outlining the liquidation procedures in place to ensure timely funding and provides Fitch monthly investment reports which are used to monitor its cash and investment position available for self-liquidity.

DISCLOSURE

HSSI covenants to provide bondholders with audited annual information within 120 days of fiscal year-end and unaudited quarterly statements within 45 days of quarter-end to the national recognized municipal securities information repositories and through Digital Assurance Certification, L.L.C. The content of HSSI's disclosure to-date has been excellent and includes a balance sheet, income statement, cash flow statement, utilization statistics, and management discussion and analysis.

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

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 30, 2013.

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=826269

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