OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB' rating on the following outstanding revenue bonds issued on behalf of Centegra Health System and Affiliates, IL (Centegra).

--$134.7 million Illinois Finance Authority, series 2014A;
--$190.4 million Illinois Finance Authority, series 2012.

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the unrestricted receivables of the obligated group and a mortgage interest in certain property of the obligated group. There is no debt service reserve fund.

KEY RATING DRIVERS

NEW HOSPITAL TO OPEN IN AUGUST: Centegra's new 128-bed hospital in Huntley is expected to open in early August. The hospital is in a growing community in northwest Illinois, about 16 miles from the flagship campus in McHenry. Centegra has maintained an ambulatory presence for several years on the Huntley campus to capture patient volume in the area and Fitch expects that the hospital will be accretive to the system after the start-up phase.

IMPROVED PROFITABILITY: Centegra generated improved operating margins in fiscal 2015 and six-months of 2016 after posting weaker results in 2014. Operating and EBITDA margins improved in 2015 to 0.7% and 9.8%, respectively, from -0.3% and 8.3% in fiscal 2014. The momentum has continued in the first six months of fiscal 2016 with an operating margin of 1.3% despite the system's ongoing investment in its employed physician, information technology (IT) and outpatient facilities. The improved results in 2015 and year to date 2016 are primarily a result of the more favorable payor mix from Medicaid expansion combined with the organization's focus on maintaining lean staffing levels and reducing the cost per employed physician.

ELEVATED LEVERAGE: The system's debt metrics have been stressed since the $193 million debt issuance in 2014 to pay for the construction on the new hospital. Maximum annual debt service (MADS) of $24.8 million equates to a high 5.4% of fiscal 2015 revenues compared to the 'BBB' median of 3.6%. MADS coverage by EBITDA was light at 1.9x in fiscal 2015, although improved from 1.5x in fiscal 2014. Interest is capitalized through fiscal 2017.

PLANNED ACQUISITION BY NORTHWESTERN: Centegra and Northwestern Memorial Healthcare (NMH; not rated by Fitch) announced in April that they had signed a letter of intent (LOI) regarding NMH's proposed acquisition of Centegra. If regulatory approval is received, the transaction is anticipated to close in calendar 2016. The acquisition would allow the Centegra hospitals to remain competitive in their consolidating market.

COMPETITIVE SERVICE AREA: Centegra operates in an area with favorable demographics that is a source of credit strength but also generates competition from other providers that are vying for patients in this attractive market. Competitive activity from two Advocate Health Network facilities (rated 'AA'; Stable Outlook, Advocate Good Shepherd and Advocate Sherman Hospital) could limit some of the benefits expected to accrue upon opening of the new facility.

RATING SENSITIVITIES
POSSIBLE FUTURE ACQUISITION: The main driver of a possible rating change is the successful completion of the acquisition by NMH. Fitch views the proposed transaction as a credit positive and believes Centegra will benefit from NMH's size, scale and financial resources.

MAINTAIN FINANCIAL PROFILE: If the acquisition is not finalized, Fitch expects Centegra's investment in the new campus, its integrated physician operating platform, and growing service area to generate slightly improved cash flow to provide adequate coverage for its higher debt burden.

CREDIT PROFILE
With the opening of the new hospital in Huntley, Centegra will be a three-hospital system with a total of 413 licensed beds. The main hospital is 179-bed Centegra Hospital McHenry (includes 22 rehab beds), 106-bed Centegra Hospital Woodstock (includes 34 mental health beds) and 128-bed Centegra Hospital Huntley (Centegra-Huntley). The system generated $456.3 million in total revenues in fiscal 2015 and its primary service area is McHenry County.

KEY MARKET DEVELOPMENTS

Centegra is currently pursuing two major market strategies. Fitch expects that these developments, the upcoming opening of Centegra-Huntley and the planned acquisition by NMH, are both potentially beneficial to Centegra.

Centegra-Huntley has been under construction for two years and is expected to open on Aug. 9th. It is a full complement hospital with obstetrics and a previously approved cath lab that will be opened as of the first day of operations. The lawsuit filed by two competitors contesting the construction of the new facility was decided in Centegra's favor on April 22, 2006, affirming the Illinois Health Facilities and Service Review Board's decision to grant the Certificate of Need to construct Centegra-Huntley.

Centegra had budgeted to spend $92 million ($10 million from operations) in the current fiscal 2016 to complete the new hospital. The project is on-time and within budget. Stabilization at Centegra-Huntley is expected by 2019, which is when debt service increases to $24.7 million. The new facility is expected to help Centegra expand its footprint in the growing southern portion of McHenry County and Northern Kane County.

Even with three hospitals in a growing demographic area and a large employed provider network (Centegra Physician Care) that is capturing a growing number of outpatient physician visits, Centegra is continuously challenged to defend its market share from competing providers, in particular Advocate Sherman, Advocate Good Shepherd and Mercy Health Corporation. Centegra is the market leader in McHenry County, but its market share for inpatient services decreased slightly to 42% in 2015 from 45% in 2013 as utilization has been mostly flat year over year. With the proposed acquisition by a larger regional system, Centegra should be able to access additional resources required to continue to invest in key strategic initiatives. Centegra believes that the proposed transaction will allow its healthcare offerings to remain local yet competitive.

IMPROVED LIQUIDITY IN THIRD QUARTER

The six month interim statements for fiscal 2016 reflect a lower cash position primarily as a result of Centegra's spending on strategic physician acquisitions and investments in 2016. Unrestricted cash decreased to $170.7 million as of Dec. 31 from $207 million at year-end 2015. In an effort to replenish its cash position, Centegra monetized eight medical office buildings (MOBs) with a sell and lease-back of the properties. The sale closed in April for $41 million in cash and generated a non-operating gain on sale of $23.1 million.

DISCLOSURE
Centegra covenants to provide annual audited financials within 150 days of fiscal year end and unaudited quarterly financials for the first three fiscal quarters within 45 days of quarter end and within 60 days of the fourth quarter.