OREANDA-NEWS. Fitch Ratings has affirmed the 'A' rating on approximately $117 million of series 2004 and series 2012 revenue bonds issued by Illinois Finance Authority on behalf of SwedishAmerican Health System (SAHS).

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group. University of Wisconsin Health is not obligated on SAHS's debt.

KEY RATING DRIVERS

DIVISION OF UW HEALTH: On Jan. 1, 2015, SAHS became part of University of Wisconsin Health (UW Health) through UW Health's subsidiary, Regional Division, Inc. Fitch views the relationship favorably and expects that SAHS will be able to enhance its clinical service offerings and its regional brand as part of UW Health.

LEADING MARKET SHARE IN COMPETITIVE AREA: SAHS maintains the leading market position in the competitive Rockford metropolitan service area. As related by management, in 2015 SAHS captured nearly 38% inpatient share compared to Rockford Memorial Hospital at 28% and St. Anthony's Hospital at 24% (SAHS's market share increased in the first three months of 2016).

GOOD LIQUIDITY: SAHS's liquidity position remains solid for the rating category, with 198 days cash on hand and 188% cash-to-debt at fiscal year end (FYE) 2016(unaudited; year ending June 30). Fitch notes that growth in unrestricted cash and investments has been solid, increasing 24% from May 31, 2013.

THIN OPERATING CASH FLOW MARGINS: As part of joining UW Health, SAHS changed its FYE from May 31 to June 30. In the six-month audited period ended June 30, 2015, SAHS recorded an operating EBITDA margin of 7.5%. In unaudited fiscal 2016 (12-month period as of June 30), SAHS recorded an operating EBITDA margin of 6.9%. Historically, SAHS's operating EBITDA margin has lagged 'A' category medians.

ADEQUATE DEBT COVERAGE: SAHS's debt service coverage remains adequate, despite thin operating EBITDA margins. In fiscal 2016, coverage of maximum annual debt service (MADS) by EBITDA measured 3.7x, while MADS as a percent of revenue was a light 2.2%.

RATING SENSITIVITIES

STABLE FINANCIAL POSITION: Fitch expects Swedish American Health System (SAHS) to maintain its recent trajectory of operating margins, sound liquidity, and debt service coverage. Over the longer term, SAHS should realize clinical and operational benefits from joining UW Health.

CREDIT PROFILE

SAHS is located in Rockford, IL, approximately 65 miles south of Madison, WI (where UW Health is located) and 70 miles west of Chicago. SAHS is a full-service acute care provider with 299 staffed beds (including beds at SAHS's facility in Belvidere). SAHS recorded operating revenue of over $490 million in unaudited fiscal 2016.

The 'A' rating reflects SAHS's merger with UW Health, leading market share in a competitive service area, sound liquidity, and adequate debt coverage. Fitch's concerns include SAHS's dependence on supplemental payments and modest operating EBITDA margins for the rating category.

DIVISION OF UW HEALTH

Effective Jan. 1, 2015, SAHS joined UW Health through UW Health's subsidiary Regional Division, Inc. Regional Division is the sole corporate member of SAHS.

SAHS has been clinically affiliated with UW Health for over five years, which included the development of a collaborative regional cancer center that opened in the fall 2013. Fitch views the merger with UW Health favorably and expects that SAHS will be able to enhance its service offerings and regional brand strength through its enhanced partnership with UW Health.

LEADING MARKET POSITION IN COMPETITIVE AREA

SAHS continues to maintain the leading market share in the Rockford MSA. The area is competitive, however, with the presence of two other sizeable hospitals: Rockford Memorial Hospital (part Mercy Health Corporation, rated 'A-'); and St. Anthony's Medical Center (part of OSF Healthcare, rated 'A'). Based on management data, in 2015 SAHS captured nearly 38% inpatient share (down roughly two percentage points since peaking in 2012/2013), while Rockford Memorial captured approximately 28% share and OSF roughly 24%. SAHS's market share increased in the first three months of 2016, capturing over 39% share.

Fitch expects competitive pressure to grow as St. Anthony's recently upgraded its campus and Rockford Memorial expects to build a replacement hospital near I-90 east of Rockford.

The Rockford area's socioeconomic indicators are generally modest though improved somewhat in recent years. The Rockford MSA's unemployment rate is above the national average and in-line with the Illinois average, population trends in Winnebago County, IL are stagnant to declining, the median household income level in the county is below average, and the poverty rate somewhat above average (U. S. Bureau of Labor Statistics and U. S. Census Bureau data).

GOOD LIQUIDITY

SAHS's relative balance sheet strength remains sound for the rating category, with 198 days cash on hand at unaudited FYE 2016 (208 days at audited FYE 2015) compared to the 'A' category median of 205 days. At FYE 2016, cash-to-debt of 188% and cushion ratio of 23.1x are both stronger than the respective 'A' category medians of 144% and 18.5x. Moreover, SAHS's cash management is conservative, as the investment portfolio is very liquid and over two-thirds is allocated to cash and fixed income.

THIN OPERATING CASH FLOW MARGIN FOR AN 'A' HEALTH SYSTEM

As part of the transition to UW Health, SAHS changed its FYE from May 31 to June 30. Consequently, SAHS produced a 12-month audit through May 31, 2014, a seven-month audit through Dec. 31, 2014, and a six-month audit through June 30, 2015. June 30, 2016 will be the next 12-month audit period.

In the six-month audited period as of June 30, 2015, SAHS recorded an operating EBITDA margin of 7.5% compared to a 10.6% operating EBITDA margin for the seven-month audited period ended Dec. 31, 2014. For 12 months ended Jun 30, 2016, SAHS generated an operating EBITDA margin of 6.9%, which is light compared to the 'A' category median of 10.3%. Historically, SAHS's operating EBITDA margin has lagged the 'A' medians. Absent receipt of material supplemental funding such as the Medicaid Assessment Program, SAHS's operating margins would be pressured further.

Factors contributing to continued modest operating EBITDA margins in fiscals 2015 and 2016 include: (a) physician turnover due to increased competition for physician employment in the market; (b) increasing the number of employed physicians and a ramp-up in the loss per employed physician; and (c) fiscal 2016 was hit by an increase in malpractice costs that is not expected to be sustained. Long-term enhanced physician recruitment should be a key benefit associated with joining UW Health.

Management's fiscal 2017 operating margin budget is in-line with fiscal 2016 results. The budget process is still being integrated with UW Health, however, and the fiscal 2017 budget does not fully incorporate the potential synergies with UW Health or the full operating expense associated with the Epic electronic medical record (EMR) system rollout.

ADEQUATE DEBT COVERAGE

SAHS's debt coverage remains adequate for an 'A' rated health system, despite thin operating results. In fiscal 2016, MADS coverage by EBITDA measured 3.7x ('A' median is 4.2x) while MADS equated to a light 2.2% of total revenues ('A' median is 2.8%).

SAHS does not have exposure to a defined benefit pension plan and its operating lease exposure is manageable, which is viewed favorably.

In spring 2015, SAHS added four fixed-to-floating rate swaps, all with Bank of America. Two of the four swaps have expired. Of the two remaining, the total notional amount outstanding is approximately $70 million. One swap terminates in November 2019 and the other in February 2020. The collateral posting threshold is a termination value of negative $15 million. The net termination value of the swaps was $0 to SAHS at unaudited FYE 2016.

CAPITAL SPENDING AND DEBT PLANS

Like many health systems, SAHS is increasingly more outpatient oriented, and outpatient now represents over 60% of gross revenues. With this in mind, the system is planning to build two outpatient physician clinics (combined estimated cost of $50 million). SAHS's other current key capital project is the installation of the Epic EMR at the hospital ((roughly $30 million capital cost, and physicians have been on Epic for some time). The Epic project is piggybacked off UW Health's existing platform, and management notes the project would have been much more expensive without UW Health. SAHS is also considering the upgrade of inpatient space to all private rooms, although the scope and cost estimates of this project are still being researched.

While SAHS may consider issuing new money debt depending on the development of its capital strategy, it is anticipated that any new debt would be issued by UW Health.

DISCLOSURE

SAHS covenants to provide quarterly disclosure within 60 days of the quarter end and annual audited financials to bondholders, and voluntarily distributes to EMMA. Disclosure to date has included a balance sheet, income statement, and operating statistics for the obligated group.

Financial covenants include: minimum debt service coverage of 1.5x (springing mortgage), 1.1x (consultant call-in), and 1.0x (event of default); minimum cash on hand of 75 days (springing mortgage and consultant call-in) and 50 days (event of default); and maximum debt-to-capitalization of 60% (springing mortgage and consultant call-in). SAHS also has a minimum credit rating covenant of 'BBB+'. SAHS's private placement has the same financial covenants as the master trust indenture.