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Fitch Downgrades Dignity Health (fka Catholic Healthcare West), CA to 'A'; Outlook Stable

SAN FRANCISCO--(BUSINESS WIRE)-- Fitch Ratings assigns a long-term rating of 'A' to up to $500 million in Dignity Health, CA taxable bonds, series 2012.

In addition, Fitch has downgraded to 'A' from 'A+' the ratings on approximately $3.5 billion of the organization's outstanding debt. For certain bonds, the 'A' rating is an underlying rating.

The Rating Outlook is Stable.

Proceeds from the taxable series 2012 fixed rate bonds will refinance $310 million in a line of credit draw that Dignity Health used to finance the acquisition of U.S. HealthWorks. Remaining bond proceeds will reimburse Dignity Health up to $185 million for prior expenditures. Pro forma maximum annual debt service (MADS) as provided by Dignity Health is $339 million and is covered 3.2 times (x) by fiscal 2012 EBITDA.

SECURITY

Joint and several pledge of the gross revenues of the Dignity Health obligated group.

KEY RATING DRIVERS

COMPRESSED FINANCIAL PERFORMANCE: The rating downgrade reflects the continued compression in Dignity Health's operating profitability since fiscal 2009. Impacted by recessionary and budgetary pressures in California and Arizona service markets, overall financial metrics lag Fitch's 'A' category medians and are not expected to improve materially over the near term as the organization implements its strategic growth and operating improvement initiatives.

TRANSFORMATIVE GROWTH STRATEGY: Dignity Health is undertaking strategic growth initiatives that, aided by its new governance structure, are intended to expand its operating footprint beyond the three states (CA, AZ and NV) in which it currently operates. The recent acquisition of U.S. HealthWorks is intended to diversify Dignity Health's geographic and service line revenue generation and promote further growth opportunities. While Fitch views management's desire to diversify beyond its core markets favorably, the strategy does introduce increased execution risk.

HEALTHCARE REFORM READINESS UNDERWAY: Fitch believes Dignity Health is well underway to becoming a clinically-integrated healthcare provider able to thrive under a value-based reimbursement operating environment. Through strategic affiliations and acquisitions, operating agreements, and physician alignment strategies, Dignity Health is striving to lower its cost structure and improve quality outcomes as it prepares for a post healthcare reform era.

NEW BRANDING AND GOVERNANCE STRUCTURE: On Jan. 17, 2012, Catholic Healthcare West became known as Dignity Health, a not-for-profit organization that is not an official ministry of the Catholic Church. A new self-perpetuating Board of Directors was put in place in lieu of a Board of Directors that was appointed by representatives of the founding religious orders. Fitch believes that the new name and governance structure broadens the organization's future growth and partnership opportunities and should allow for greater flexibility in strategic decision making.

CREDIT PROFILE

Dignity Health

Effective Jan. 17, 2012, Catholic Healthcare West changed its name to Dignity Health and made certain changes to its internal governance structure. It remains a not-for-profit organization but is not an official ministry of the Catholic Church.

A new nine-member self-perpetuating Board of Directors governs over Dignity Health's 39 Catholic and non-Catholic Hospitals. The Board comprises members from the community at large and two women religious from Dignity Health's founding congregations. The Sponsorship Council, which represents the founding congregations, retains certain reserve rights over Dignity Health's 25 Catholic-sponsored hospitals.

Dignity Health is a not-for-profit health system with 39 hospitals, 33 of which are located in California, three in Arizona, and three in Nevada. Total revenues in fiscal year 2012 were $10.5 billion. Financial figures cited in this report area based on audited financial results for fiscals 2012 and 2011 (ending June 30), which exclude the results of Saint Mary's Regional Medical Center (380-bed facility in Reno, Nevada) and the operations of Saint Mary's Multi-Specialty Clinic. The medical center and the clinic were sold on June 30, 2012.

Compressed Financial Profile

The rating downgrade reflects a financial profile compressed by a pressured reimbursement environment, adverse shifts in payor mix, and moderate capital spending. Though liquidity remains adequate, core profitability and debt-related metrics continue to lag Fitch's 'A' category medians and are not expected to improve markedly over the medium term.

Weak Profitability

Despite Dignity Health's large and diversified revenue base, core profitability continues to be hampered by declining patient volumes, unfavorable shifts in the payor mix, and reductions in governmental reimbursement rates. Dignity Health reported $162.4 million in operating income for fiscal 2012, down from a restated $186.4 million in the prior fiscal year (excluding impact of changes in swap fair values). Overall, profitability margins have consistently lagged Fitch's 'A' category medians. Fiscal 2012 operating and operating EBITDA margins were 1.5% and 7.3%, respectively, down from 3% and 9.2% for fiscal 2009, and are well below Fitch's respective 'A' medians of 2.8% and 9.8%.

Additionally, the near break-even fiscal 2012 results were substantially driven by $233.7 million in net additional operating income related to California's hospital provider fee program ($198.8 million in fiscal 2011), which Fitch viewed with concern. However, Fitch believes that management remains committed to and focused on reducing, if not eliminating, this dependence on such one-time funds through ongoing strategic growth and operating improvement initiatives.

Growth Strategy

Under the new name and structure, Dignity Health seeks to grow nationally and explore new partnership opportunities beyond the three states in which it currently operates. Fitch believes that Dignity Health will seek to expand in favorable markets as it may exit or restructure underperforming ones, and diversify its non-acute care business lines.

On Aug. 10, 2012, Dignity Health acquired U.S. HealthWorks - a multi-state for-profit operator of occupational health and urgent care centers with 174 centers in 15 states. Additionally, and in August 2012, Dignity Health entered into a Memorandum of Understanding to acquire Ashland Community Hospital. The transaction may close within this calendar year and would be Dignity Health's first expansion into Oregon. These strategic moves are intended to diversify Dignity Health's geographic and service line revenue generation and promote further growth opportunities.

Adequate Liquidity

Despite moderate capital spending, balance sheet metrics remain in line with Fitch's 'A' category medians. On June 30, 2012, Dignity Health had $4.6 billion in unrestricted cash and investments, equating to a good 181.6 days-cash-on-hand but a modest 100.6% cash-to-debt position, when compared to Fitch's respective 'A' category medians of 191 days and 116.4%.

Debt Profile

Debt burden is above average, having risen steadily to fund Dignity Health's sizable capital plan. Post issuance of up to $500 million in series 2012 taxable revenue bonds, pro forma long-term debt totals $5 billion and comprises approximately $3.6 billion in fixed rate debt, $1.3 billion in variable rate debt, and $147 million in various notes payable and capitalized lease obligations. Included in its variable rate debt are $789.5 million in long term bonds supported by letters of credit from four banks. In June 2012, Dignity Health renewed two letters of credit (LOC) provided by J.P. Morgan Chase and is currently working to replace four and two LOCs provided by BofA and Citi, respectively.

Pro forma MADS coverage of 3.2x by FY 2012 EBITDA is weak, compared to Fitch's 'A' category median of 4.1x, and pro forma debt to capitalization of 56% is high relative to Fitch's 'A' median of 40.7%.

Dignity Health has 16 floating to fixed-rate swaps and four fixed-to-floating risk participation agreements. Counterparties to the floating to fixed rate swaps are JPMorgan, Citibank and Deutsche Bank. As of Aug. 31, 2012, the swaps had a current notional amount of $940.6 million, with a mark-to-market value of negative $269.8 million. Dignity Health is prohibited from posting collateral on derivative instruments under its Master Trust Indenture.

Sizable Capital Plan

Dignity Health's four-year (2013 - 2016) capital plan totals $2.6 billion. Capital expenditure will address seismic upgrade projects, outpatient expansion needs, strategic physician engagement initiatives, information technology investments, equipment replacement and other routine maintenance. However, the plan does not account for opportunistic capital expenditures related to potential mergers and acquisitions. Funding sources include operating cash flow, investment income, philanthropy, unspent bond proceeds, and future borrowings.

Fitch views Dignity Health's strategic capital investments positively as it is fast becoming a clinically-integrated healthcare provider, built on strong physician alignment, new and enhanced clinical documentation system, and savvy affiliations and partnerships. Further, these investments are designed to lower the cost of providing care while simultaneously improving quality outcomes, which are critical ingredients for success under a value-based operating environment.

Stable Outlook

The Rating Outlook is Stable. Fitch believes that Dignity Health's large and diversified revenue base should preclude further rating pressure as the organization implements various operating improvement strategies, revenue and geographic diversification opportunities, and strategic capital reinvestment.

Disclosure

Disclosure practices are some of the best in Fitch's portfolio. Dignity Health covenants to disclose audited annual financial statements and unaudited quarterly results to bondholders. Quarterly condensed financial statements include a consolidated income statement, balance sheet, cash flow statement, and management discussion. In addition, management hosts quarterly investor calls and posts all financial information on its website at 'www.dignityhealth.org'.

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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Fitch Ratings
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com
or
Primary Analyst:
Michael Borgani, +1-415-732-5620
Director
Fitch, Inc.
650 California Street, Fourth Floor
San Francisco, CA 94108
or
Secondary Analyst:
James LeBuhn, +1-312-368-2059
Senior Director
or
Committee Chairperson:
Eva Thein, +1-212-908-0674
Senior Director

Source: Fitch Ratings