OREANDA-NEWS. Fitch Ratings has assigned an 'AA-' rating to the following bonds expected to be issued on behalf of Mission Health System, Inc. (Mission):

--\$100,000,000 North Carolina Medical Care Commission health system revenue refunding bonds, series 2015;
--\$25,000,000 Mission Health System taxable health system revenue bonds, series 2015.

Fitch has also affirmed the 'AA-' rating on the following bonds issued by or on behalf of Mission:

--\$6,070,000 North Carolina Medical Care Commission hospital revenue bonds series 2003;
--\$239,330,000 North Carolina Medical Care Commission hospital revenue bonds series 2007;
--\$58,380,000 North Carolina Medical Care Commission health system revenue bonds series 2010;
--\$179,850,000 Mission Health System taxable health system revenue bonds series 2012.

The series 2015 bonds are expected to be issued as fixed rate bonds. Bond proceeds will be used to advance refund a portion of the outstanding series 2007 bonds, to finance the costs of various capital projects and to pay costs of issuance. The series 2015 bonds are expected to price the week of Feb. 23 through negotiation.

The Rating Outlook is Stable.

SECURITY

The bonds are general unsecured, joint and several obligations of the obligated group. However, Mission has covenanted to cause designated members to make payments necessary to pay debt service.

KEY RATING DRIVERS:

SIGNIFICANT CAPITAL PROJECT: The Mission Redesign Plan includes the consolidation of Mission Hospital's two adjacent campuses (St. Joseph's and Memorial) with the goals of addressing existing capacity constraints, reducing redundant services and achieving operating efficiencies. The project, which is estimated to cost \$419 million with an expected opening date in 2019, is expected to compress operating profitability and liquidity metrics in the near term. Management is contemplating issuing additional debt in 2017 or 2018 to fund a portion of the project.

EXPECTED PROFITABILITY COMPRESSION: Operating profitability continued to compress in fiscal 2014, with operating EBITDA margin decreasing to 9.4% from 10.5% in fiscal 2013. The compression was expected and generally in line with projections related to Mission's campus consolidation project. Operating profitability rebounded during the three month interim period ending Dec. 31, 2014, with operating EBITDA margin increasing to 10.7%. The improvement reflects expense reduction and revenue enhancement initiatives.

MODERATING DEBT BURDEN: Mission's pro forma debt burden has consistently moderated over the years due to revenue growth, with pro forma maximum annual debt service (MADS) decreasing from 4.4% of operating revenue in fiscal 2011 to 3% in fiscal 2014. MADS coverage by EBITDA of 5.5x in fiscal 2014 was strong, but MADS coverage by operating EBITDA of 3.2x was light for the rating category.

SOLID LIQUIDITY METRICS: Liquidity metrics have decreased due to spending associated with the campus consolidation project, however, 265.3 days cash on hand (DCOH), 23.5x cushion ratio and 162.5% cash to debt remain solid for the rating category and are favorable compared to projected results.

STRONG MARKET POSITION: Mission maintains a leading 43% market share in its 18-county total service area, with no competitor holding greater than 8% market share. However, competitive pressure may increase due to consolidation in the service area.

RATING SENSITIVITIES

SUFFICIENT OPERATING CASH FLOW: Fitch expects that Mission will maintain operating cash flow consistent with its current rating to fund its campus consolidation project and that liquidity levels will remain in line with management's forecast. A sustained weakening in cash flow or liquidity, or the unexpected issuance of additional debt could result in downward rating pressure.

CREDIT SUMMARY:

Based in Asheville, NC, Mission is an integrated delivery system operating a regional tertiary care hospital, five community hospitals, a long-term acute care hospital and various related entities. Mission executed affiliation agreements in fiscal 2013 to become the sole member of Transylvania Health System and Angel Medical Center. Prior to the transactions, Mission had operated both hospitals under management agreements. Total operating revenues equaled \$1.38 billion in fiscal 2014. Fitch's analysis is based on the consolidated results of Mission. The combined obligated group accounted for 80.5% of consolidated operating revenues and 95.5% of consolidated total assets in fiscal 2014.

SIGNIFICANT CAPITAL PROJECT

Mission is currently in the process of executing a campus consolidation project under which the system will consolidate the operations of Mission Hospital's two adjacent campuses (St. Joseph's and Memorial) to address current capacity constraints and to increase operating efficiencies. The two campuses are located across the street from one another and collectively operate as Mission Hospital. The project is estimated to cost \$419 million. Fitch views the project favorably as it should reduce redundant services and improve operating efficiencies upon completion. The project is expected to be completed in 2019.

The project is expected to be funded by the series 2012 bond proceeds, a portion of the series 2015 bond proceeds and operating cash flows. Mission may issue an additional \$100 million in fiscal 2017 or 2018 to provide additional project funding. Pro forma includes the potential new issuance.

EXPECTED PROFITABILITY COMPRESSION

At the time of the issuance of Mission's series 2012 bonds, operating profitability was projected to compress in fiscal years 2012 through 2015 due to costs related to the system's campus consolidation project. Operating and operating EBITDA margins decreased from 5.3% and 13% in fiscal 2012 to 2.4% and 10.5% in fiscal 2013 and further compressed to 1.6% and 9.4% in fiscal 2014. However, the compression was generally in line with the original projections, although slightly below in fiscal 2014.

Operating profitability rebounded in the three month interim period ending Dec. 31, 2014, with operating and operating EBITDA margins increasing to 3.2% and 10.7%, exceeding the original projections. The improvement was primarily due to cost containment and revenue enhancement initiatives, including approximately \$40 million of cost reductions achieved to date. Updated projections target operating and operating EBITDA margins of 2.5% and 10.2% in fiscal 2015, which Fitch views as reasonable.

Mission's operating profitability has been historically significantly aided by supplemental government funding from sources including Medicare and Medicaid disproportionate share funds and North Carolina's Medicaid assessment program. The historical supplemental funding totaled approximately \$84.4 million in fiscal 2014 and reflects Mission's high proportion of Medicare and Medicaid payors as a percent of its patient revenue. Medicare and Medicaid accounted for 66% of Mission's gross revenue in fiscal 2014. Fitch views the high exposure to supplemental government funding as a credit concern given the expected future decline in disproportionate share funding, particularly given North Carolina's decision not to expand Medicaid under the PPACA.

MODERATING DEBT BURDEN

The system's debt burden has moderated due to revenue growth. Pro forma MADS as a percent of revenue decreased from a high 4.4% in fiscal 2011 to a more moderate 3% in fiscal 2014. During this period, operating revenues increased 47.7% due in part to the acquisitions of Transylvania Health System, Angel Medical Center, Highland Cashiers Hospital and CarePartners. However, Mission's debt burden remains elevated relative to Fitch's 'AA' category median of 2.6%. MADS coverage by EBITDA was solid at 5.5x in fiscal 2014, reflecting, in part, strong realized investment gains, however, MADS coverage by operating EBITDA was light at 3.2x. Management is projecting MADS coverage to compress to 3.9x in fiscal 2015 before rebounding to 4.9x in fiscal 2016 and increasing beyond.

Pro forma MADS is estimated to equal \$40.8 million and includes the pro forma impact of an expected bond issuance in late 2017 or early 2018. The series 2015 bond issuance is not expected to have a material impact on Mission's debt burden, with pre-series 2015 MADS equal to \$40.5 million. Without the additional \$100 million of bonds, pro forma MADS would have equaled \$39.5 million. The muted impact of the series 2015 and potential 2017 or 2018 bond issuances is due to a combination of the expected interest rate savings from the series 2015 refunding and the system's ability to back end load principal of the 2017 or 2018 bonds.

SOLID LIQUIDITY METRICS

Similar to operating profitability, unrestricted liquidity was projected to decrease during the campus consolidation project, with cash to debt and DCOH decreasing to 139.4% and 245.1 days in fiscal 2014 in the original projections. Unrestricted cash and investments decreased 6.2% since fiscal 2013 to \$985.9 million at Dec. 31, 2014. However, liquidity metrics at Dec. 31, 2014 are favorable to the original projections with 265.3 DCOH, 23.5x cushion ratio and 162.5% cash to debt. Liquidity metrics are currently projected to continue to decline as Mission funds its campus consolidation project with DCOH projected to decrease to a low of 253 days in fiscal 2018, below Fitch's 'AA' category median of 277.1 days, before beginning to rebound.

STRONG MARKET POSITION

Fitch views Mission's strong market position in its service area as a key credit strength which contributes to Mission's operating stability. The system maintained a leading 93% market share in its primary service area (PSA) in fiscal 2014 and a leading 43% in its total service area. Total service area market share increased from 41.4% in fiscal 2008, but declined slightly from a high of 43.7% in fiscal 2013. The total service area has experienced consolidation, primarily due to acquisitions of several small community hospitals by Duke LifePoint. Continued consolidation could lead to increased competition.

DEBT PROFILE

Subsequent to the series 2015 bond issuance, Mission will have approximately \$590 million of total debt outstanding. Total debt includes \$23.8 million of variable rate bonds issued by Angel Medical Center and Transylvania Health System and guaranteed by Mission. Mission has not had to make any payments under either guaranty to date. The pro forma debt profile will include 94.6% underlying fixed rate bonds and 5.4% underlying variable rate bonds. Fitch views the system's debt profile as conservative. Mission is counterparty to a fixed payor swap converting the series 2003 to synthetic fixed rate. There are no collateral funding requirements so long as the system's bond rating does not fall below 'A+.'

DISCLOSURE

Mission Health System, Inc. covenants to provide annual disclosure no later than 120 days after the end of each fiscal year and quarterly disclosure within 45 days following the end of each fiscal quarter. Disclosure will be provided through the Municipal Securities Rulemaking Board's EMMA system.