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Fitch Downgrades WakeMed Health System's (NC) Revs to 'A+'; Outlook Revised to Stable
[June 10, 2016]

Fitch Downgrades WakeMed Health System's (NC) Revs to 'A+'; Outlook Revised to Stable


Fitch Ratings has downgraded the rating on the following bonds issued by the North Carolina Medical Care Commission on behalf of WakeMed Health System (WakeMed) to 'A+' from 'AA-':

--$283,250,000 health care facilities revenue refunding bonds series 2012A;

--$75,000,000 health system revenue bonds series 2009B;

--$66,815,000 health system revenue bonds series 2009C.

The ratings for the series 2009B and 2009C bonds are underlying ratings.

The Rating Outlook has been revised to Stable from Negative.

SECURITY

Fixed-rate bonds are secured by an interest in pledged assets and variable-rate bonds are secured by a direct-pay letter of credit from Wells Fargo (News - Alert) Bank.

KEY RATING DRIVERS

NEGATIVE FY2015 OPERATING MARGIN: The downgrade is driven by WakeMed's negative operating margin in FY2015 (September 30th year end) and an additional $100 million in debt issued, with WakeMed's credit profile now more consistent with the 'A' category. The negative operating margin in FY2015 followed weaker results in both FY2013 and FY2014.

STABLE OUTLOOK: The Stable Outlook incorporates WakeMed's strong FY2016 YTD performance. The six month FY2016 results show a 4.9% operating margin and 4.3x maximum annual debt (MADS) coverage, much improved over the 1.5% operating margin and 2.7x MADS coverage for the first six months of FY2015. It also reflects Fitch's view that the CEO, who was named the permanent CEO since Fitch's last review, and a new CFO will continue to execute on their improvement strategy.

LIQUIDITY ADEQUATE FOR RATING LEVEL: At March 31, 2016, WakeMed had $551.6 million in unrestricted cash and investments, which equated to 231.6 days cash on hand, and 103% cash to debt, relative to Fitch's 'A' category medians of 205.3 days and 143.7% cash to debt.

GOOD MARKET POSITION: Fitch views WakeMed's leading 45% inpatient market share (2015 data) in Wake County, from where approximately 70% of WakeMed's admissions originate, as a key credit strength. Both Wake County and the City of Raleigh GOs are rated 'AAA' by Fitch, which reflect the area's continued population growth, good wealth indicators, and diverse economic base.

COMPETITVE SERVICE AREA: There are strong competitors in the service area: Duke University Health System (DUHS, rated 'AA'), UNC Health System (UNCHS), and Rex Hospital (rated

'AA-'), but in Fitch's view WakeMed's strong base of primary care physicians, which should be bolstered further by its Accountable Care Organization (ACO), secure its market position.

RATING SENSITIVITIES

POSITIVE PERFORMANCE EXPECTED: Fitch expects WakeMed Health System to sustain its positive operating performance and, coupled with its good liquidity for the rating level, should provide for stability at the current rating level. WakeMed's budget for FY2016 is for $27 million in operating income, which WakeMed is far ahead of with $24.7 million in operating income for the first six months of the year.

CREDIT PROFILE

Headquartered in Raleigh, NC, WakeMed is an integrated health system with two acute care hospitals, a 98-bed rehab hospital, and other related entities primarily serving Wake County and surrounding areas. In FY2015, WakeMed had total revenues of approximately $1 billion.

CREDIT PROFILE CONSISTENT WITH RATING

The downgrade reflects a weaker performance in FY2015 coupled with the issuance of an additional $100 million in debt since Fitch's last review. The Rating Outlook for WakeMed's was previously Negative due to weaker performance in FY2013, when it posted a negative 1.4% operating margin. WakedMed had an essentially breakeven performance in FY14 and then a negative 4.8% operating margin in FY2015.

FY2015 performance was affected by $52 million in one-time strategic investments due to an information technology implementation, the opening of WakeMed North, and the establishment of an ACO. However, performance was still thin backing out the one-time items with a 0.2% operating margin and an 8.4% operating EBITDA margin. The one-time exenses were all key strategic investments that in Fitch's view should be accretive to WakeMed over the longer term.



The first six months of FY2016 has begun to show the improvement. Volumes are up, helped by the first full year of operations at WakeMed North. WakeMed North, which has a focus on children and women's health, is a 61-bed hospital that was built after WakeMed had located a multi-specialty Healthplex on the site to establish a clinical presence. The success of the healthplex led to the investment in an inpatient facility. Northern Wake County is a growing part of an already strong service area.

Through 2Q2016, WakeMed has posted a 4.9% operating margin, a 14.4% operating EBTIDA margin, and 4.3x MADS coverage, relative to Fitch's 'A' medians of 3.6%, 10.4%, and 4.3x.


With these major one time investments done, WakeMed should be able to execute on other efficiency and revenue initiatives that should keep performance consistent with the 'A' category medians. At Fitch's last rating action in 2014, WakeMed had named an interim CEO. His appointment is now permanent, and he has brought on a new CFO. Fitch views the new management team positively, believing they should be able to continue to execute on the performance that was posted through 2Q2016.

At March 31, 2016, WakeMed had $551.6 million in unrestricted cash and investments, which equated to 231.6 days cash on hand, and 103% cash to debt, relative to Fitch's 'A' category medians of 205.3 days and 143.7% cash to debt. Unrestricted cash and investments had fallen to $493.6 million in FY2014. The improvement in unrestricted liquidity was helped by the $100 million debt issuance, which was used to repay WakeMed for prior capital expenditures.

WakeMed has been spending on capital, including WakeMed North and the information technology implementation. Capital spending averaged 132.8% of depreciation over the last four years relative to a median of 115%.

Debt Profile

In 2015, WakeMed issued $100 million of variable rate bonds, which were privately placed with BB&T bank for a five-year period ending Oct. 1, 2020. The debt issuance increases WakeMed's variable rate and bank exposure to 46% from 33%. Total long-term debt at year end FY2015 was $514.8 million of which $237.7 million was variable rate. Mitigating the concerns around this level of variable rate and bank exposure is WakeMed's relatively conservative investment allocation with mostly fixed income investments.

The other series of variable rate debt are supported by letters of credit (LOC) from Wells Fargo. The LOCs are set to expire in 2017, but renewal of the LOCs is not a concern given WakeMed's access to the capital markets and the good liquidity position.

The additional debt increased WakeMed's MADS by approximately 25%. As a result, WakeMed's debt load is slightly elevated with MADS as a percent of revenue of 3.3x and debt to EBITDA of 3.8x, above their respective medians of 2.8% and 3x, at march 31, 2016.

MADS coverage has been thin the past three years, averaging 2.7x relative to a median of 4.2x, but Fitch expects coverage closer to the median moving forward.

DISCLOSURE

WakeMed provides annual and quarterly disclosure to EMMA.

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

Applicable Criteria

Not-for-Profit Hospitals Rating Criteria (pub. 04 Dec 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=874120

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1005895

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1005895

Endorsement Policy

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

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.


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