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Fitch Rates Banner Health (AZ) Series 2012 Revs 'AA-'; Outlook Stable

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has assigned 'AA-' ratings to the following Arizona Health Facilities revenue bonds issued on behalf of Banner Health System (Banner):

--$180.0 million series 2012A revenue bonds;

--$70.0 million series 2012B Taxable revenue bonds.

In addition, Fitch has affirmed the outstanding 'AA-' long-term ratings on approximately $2.2 billion of bonds issued on behalf of Banner. For certain bonds, the 'AA-' rating is an underlying rating.

The Rating Outlook is Stable.

The 2012 bonds are expected to be issued as fixed-rate debt. Proceeds from the series 2012A bonds will be used to fund the construction projects at its Banner Estrella and Banner Baywood medical centers and to pay costs of issuance. The series 2012B taxable bonds are rate sensitive with proceeds used to refund a portion of the corporation's series 2008D bonds issued through the Arizona Health Facilities Authority. The bonds are expected to price the week of Oct 15th.

SECURITY

A gross revenue pledge of Banner Health as sole member of the obligated group.

KEY RATING DRIVERS

STRONG PROFITABILITY: Despite the negative impacts from the recession on the Phoenix service area, Banner has been able to generate strong and consistent operating results that exceed Fitch's 'AA' category medians. From 2009 - 2011, Banner has generated operating margins between 4.8% and 6.9% and operating EBITDA margins between 12.3% and 13.3%.

LEADING MARKET POSITION: Banner further extended its leading market position in the important Phoenix metropolitan service area to 44.8% in 2011 from 42.3% in 2009 reflecting the system's investment in facilities and physicians. Fitch believes the system derives further credit strength from its geographic diversity as it operates and maintains a leading market share position in the Greeley and Loveland CO markets.

IMPROVING BALANCE SHEET METRICS: Banner's unrestricted cash and investments and liquidity metrics have shown year over year improvement in each of the last three fiscal years while certain leverage ratios have further moderated reflecting the system's very strong cash flow generation and declining capital spending. Historical coverage of pro-forma maximum annual debt service in 2010 and 2011 is solid at 4.7x and 4.4x, respectively.

TRANSITION TO VALUE BASED MODEL: Banner is positioning itself to compete and financially thrive under a value-based operating model whereby transparency and quality outcomes are key differentiating factors. As Banner invests heavily in its physician alignment strategies, IT platforms, and partnerships with commercial payors, Banner is fast becoming a clinically and vertically integrated organization focused on care coordination and population health management.

CREDIT PROFILE

Banner Health is a large, integrated health care provider with operations in seven states that include 22 acute care hospitals, over 1,038 employed physicians, outpatient and post-acute facilities and insurance products. In 2011 (year ending Dec 31), Banner generated over $5.0 billion in total revenues. The majority of Banner's operations are located in the Phoenix metropolitan area which accounted for 77% of total revenues in 2011.

The 'AA-' reflects Banner's strong and consistent operating profitability, the growth of its leading market in the Phoenix metropolitan area and the strategic repositioning of the system to succeed in a 'post reform' reimbursement environment. Furthermore, Banner's improving liquidity position and moderating debt burden help to mitigate the operating risks as the corporation moves to and embraces value based reimbursement methodologies over volume based reimbursement.

Despite the negative impacts from the recession on the Phoenix service area, Banner has been able to generate strong and consistent operating results over the last three and half years. From 2009 - 2011, Banner has generated operating margins between 6.9% and 4.8% and operating EBITDA margins of between 13.3% and 12.3% which exceed Fitch's respective 'AA' category medians of 4.0% and 10.6%. Through the six -month interim period ended June 30th, Banner generated a 7.0% operating margin and a 14.2% operating EBITDA margin. The strong profitability reflects management's ability to successfully manage labor and supply costs and implement efficiency measures, which helped blunt increased charity care and bad debt and sharp reductions in Medicaid reimbursement.

As Banner has built out its network in the Phoenix metropolitan area, the system further extended its market share position of inpatient admissions to 44.8% in 2011 from 42.3% in 2009. Banner was the only health care provider to increase its market share position over that time frame. Fitch believes the system derives further credit strength from its geographic diversity as it operates and maintains a leading market share position in the Greeley and Loveland CO markets.

Certain of Banner's liquidity ratios are light when compared to Fitch's 'AA' category medians reflecting the corporation's heavy capital spending and investments in physicians and health care reform initiatives. However, Banner's liquidity position and metrics have shown year over year (YoY) improvement in each of the last three fiscal years reflecting the system's very strong profitability and cash flow and a reduction in capital spending. At June 30, 2012, Banner had $2.83 billion of unrestricted cash and investments (up from $1.99 billion at FYE 2009) which equates to 238 days cash on hand, an 18.0x cushion ratio and 126.8% cash to debt compared to the 'AA' category medians of 241.1, 24.1x and 169.4%. Furthermore, Banner's liquidity position and ratios are negatively impacted by its $283.5 million collateral posting requirement which is deducted from unrestricted cash and investments and equates to almost 25 days of cash on hand.

Similar to the effect on liquidity ratios, certain of Banner's leverage metrics, while moderating, remain elevated when compared to 'AA' category median. However, due to the system's strong cash flow generation historical coverage of pro-forma MADS by EBITDA has been strong and consistent at 4.1x, 4.7x and 4.4x in 2009, 2010 and 2011, respectively and is in line with the 2012 'AA' category median of 4.8x. Through the six-month interim period ended June 30, 2012 coverage of pro-forma MADS by EBITDA was a strong 5.7x.

As part of its overall strategic plan, Banner has been very proactive in readying the organization for payment reform, coordinated delivery of care, and population health management. Over the last 18 months, Banner has diligently invested in its Banner Health Network (BHN). BHN is an Accountable Care Organization that, with partnerships with several commercial payors, comprises 2,100 employed and affiliated physicians and manages 218,000 lives. Fitch believes the breadth of Banner's health care network that includes acute, outpatient, post-acute and aligned and employed physicians has well positioned the organization to succeed in a post reform environment.

The Stable Outlook reflects Fitch belief that Banner's tenured management team can successfully transition the organization in the adoption of value based revenue models and the assumption of risk on managing population health. Banner's ability to control operating cost and generate efficiencies combined with its improved liquidity position help to mitigate the risks associated with the corporation's embrace of new payment methodologies. Fitch believes Banner's strong profitability margins provide some cushion against some adverse experience in its ACO and shared savings initiatives.

Banner is counter-party on nine swaps with a total notional amount of $1.4 billion. Counter-parties include Merrill Lynch, Morgan Stanley, Wells Fargo, PNC Bank and JP Morgan. At June 30, 2012, the mark-to-market value of Banner's swap portfolio was negative $460 million which required a total of $283.5 million in collateral posting. Banner's obligation on its swap contract is on parity with payments on the bonds.

DISCLOSURE

Banner's financial reporting is excellent. Disclosure is timely and complete. Interim financial statements are presented in an audit format and include a management discussion and analysis. Furthermore, Banner hosts quarterly investor calls.

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
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Jim LeBuhn
Senior Director
Fitch, Inc.
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or
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Michael Borgani
Director
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or
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Eva Thein
Senior Director
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or
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Source: Fitch Ratings