OREANDA-NEWS. Fitch Ratings has assigned an 'A' rating to the following bonds issued on behalf of Norton Healthcare (Norton):

--$525,310,000 Louisville-Jefferson County Metro Government, KY health system revenue bonds (Norton Healthcare, Inc.), series 2016A.

In addition, Fitch upgrades approximately $825 million of parity bonds issued by the Louisville-Jefferson County Metro Government and the Kentucky Economic Development Finance Authority on behalf of Norton to 'A' from 'A-'. The rating on some of the debt is an underlying rating. Approximately $401 million of the existing bonds will be refunded as part of the 2016 transaction.

The Rating Outlook is revised to Stable from Positive.

The 2016A bonds will be issued as fixed rate. Coinciding with the 2016A bonds will be 2016B and 2016C bonds that will be direct placement bank debt (which Fitch was not asked to rate). The bond proceeds from all three bond series will be used to current refund the series 2006 bonds, refund existing taxable series 2011D and 2013B direct purchases, fund the Audubon expansion, an energy initiative, and other capital projects, reimburse Norton for prior capital expenditures, and pay the cost of issuance. Maximum annual debt service (MADS) of $78 million was provided by the underwriter. Bonds are expected to sell via negotiation the week of July 11.

SECURITY

Bonds are secured by a pledge of gross revenues of the obligated group. The series 2000B&C bonds are further secured by a debt service reserve, and the series 2000B bonds are additionally secured by a mortgage lien on certain property.

KEY RATING DRIVERS

MARKET POSITION SUPPORTS UPGRADE: The upgrade to 'A' recognizes the market strength of Norton Healthcare, characterized by a sizable revenue base (over $2 billion in revenue), a solid base of physicians, increasing patient volumes, and a leading market share. In 2015, Norton grew its inpatient market share to 51.1%, which is now twice that of its closest competitor, maintains the leading outpatient market share, and has a 96.3% inpatient market share for pediatric services. Norton's market position and its operating performance offset concerns regarding the increase in leverage with the issuance of the 2016 debt.

STRONG PERFORMANCE MAINTAINED: Norton finished FY2015 with a 4.9% operating margin and a 10.9% operating EBTIDA margin, consistent with the prior year performance and above Fitch's 'A' medians of 3.6% and 10.3%, respectively. The performance was helped by a solid 10% growth in net patient service revenue. Norton's results through the three-month period ended March 31, 2016 have remained consistent with a 5.8% operating and 11.5% operating EBITDA margin.

STEADY LIQUIDITY GROWTH: Norton's unrestricted cash and investments grew 50% from FY2012 to FY2015. Norton had $979 million in unrestricted cash and investments at March 31, 2016, which equated to 189.8 days cash on hand and 109.6% cash to debt. These trail category medians, and cash to debt will drop further after the issuance of the 2016 bonds. However, liquidity is adequate at the higher rating level and, given Norton's strong cash flow, Fitch expects liquidity to continue to grow over the next two to three years.

STRONG PHYSICIAN ALIGNMENT: Strong physician alignment has helped bolster Norton's clinical activity and revenue growth, and allowed it to pursue a successful regional growth strategy and maintain leading market share within the greater-Louisville area.

ELEVATED DEBT BURDEN: The additional debt will increase Norton's debt burden. Pro forma MADS as a percentage of revenue at year end FY2015 was 3.9% relative to Fitch's 'A' median of 2.8%, and pro forma coverage was 3.6x relative to a median of 4.2x. However, Norton is funding key strategic growth projects with the bond proceeds, and Fitch believes the debt metrics will moderate over the next few years given the strength of Norton's operations.

RATING SENSITIVITIES

STEADY PERFORMANCE EXPECTED: Norton Healthcare Inc.'s (Norton) market position should keep operations stable over the next two to three years, with Norton's debt position slowly moderating and liquidity continuing its measured growth supported by good cash flow.

CREDIT PROFILE

Norton Healthcare is an integrated health care system headquartered in Louisville, Kentucky. It operates five hospitals with 1,837 licensed (1,422 433 staffed) beds, seven outpatient centers, 13 immediate care locations, and other ancillary health services. Total revenues reported in fiscal 2015 (Dec. 31 year-end) were approximately $2 billion.

The obligated group (OG) includes Norton Hospitals (five acute care facilities in and around Louisville), and the parent corporation, Norton Healthcare Inc. Analysis was based on the consolidated entity, Norton Healthcare. At Dec. 31, 2015, the OG accounted for 84.5% of the total operating revenue, 80.5% of the total operating expenses and 87.7% of the total assets of the System, respectively.

Market Position/Strong Cash Flow

The upgrade is supported by Norton's leading market position in Louisville and the continued positive performance after lower results in 2012 and 2013 that were due to a large information technology (IT) installation. Norton finished FY2015 with a 4.9% operating margin and a 10.9% operating EBITDA margin, consistent with the prior year performance and above Fitch's 'A' medians of 3.6% and 10.3%, respectively.

Norton's results through the three-month period ended March 31, 2016 remained strong with a 5.8% operating and 11.5% operating EBITDA margin, with key volume figures including inpatient admissions and inpatient and outpatient surgeries showing growth.

Overall, the return of Norton's solid operating results is supported by successful execution of its market strategy, which has resulted in increased clinical volumes, a focus on cost savings and efficiencies (with a total of $60 million in cost taken out of the system in 2014 and 2015), a highly aligned medical staff, the leveraging of its IT system, and other strategic investments.

Norton's Medicaid exposure was high at 26% of gross revenues in fiscal 2015, but a large part is for obstetric and pediatric services, which have better reimbursement levels than Medicaid for adult services. Norton has a 96.3% inpatient market share for pediatric services in its primary service area.

In addition, Kentucky is a Medicaid expansion state, which while increasing Medicaid, has reduced Norton's self-pay to about 2% of gross revenues. Moreover, Norton netted less than $10 million in disproportionate share hospital (DSH) payments in 2015 and could absorb a reduction in those payments if the DSH program is cut.

An ongoing legal dispute between Norton and the University of Louisville over the Kosair Children's lease partnership was resolved in 2015. Norton has a 99-year ground lease on the land where the Kosair Children's Hospital is constructed. Terms of the settlement agreements include a clarification that Norton fulfilled all its financial obligations under the terms of the lease and a commitment from Norton to fund $45 million of facility improvements and capital expenditures at Kosair Children's Hospital over an eight-year period beginning Jan. 1, 2016. Fitch views the resolution of these lawsuits as a credit positive.

ELEVATED DEBT BURDEN

Norton's debt levels are elevated for the rating category, due to its sizeable capital spending. Over the last four audited years capital spending has averaged 128.7% of depreciation or approximately $108 million a year. The continued increase in patient volumes and growth initiatives are driving the additional need to build capacity and for debt.

The 2016 debt issuance will fund a master facility plan at Norton Audubon Hospital, an energy initiative that should yield cost savings and energy efficiencies, and an operating expansion at Norton Women's and Kosair Children's Hospital.

While the debt increase stresses Norton's leverage metrics, Fitch views positively these strategic investments and believes they will be accretive to longer-term financial performance as prior investments have been.

DEBT PROFILE

After issuance, Norton will have approximately $1 billion in long-term debt. The issuance will increase Norton's fixed rate debt to approximately 85% of its long-term debt up from 70%. Fitch views the level of fixed rate as a credit positive lending further stability to Norton's financial profile. Consolidated MADS will increase to $78 million from $65.2 million. Based on its covenant calculation (OG only), Norton covered its $57.1 million in debt service at 5.1x at Dec 31, 2015.

Norton has four interest rate swaps for a total notional value of $540 million, none of which qualify for hedge accounting. Norton must post collateral at the -$25 million threshold (tied to its 'A-' rating). The mark-to-market was $9 million as of Dec. 31, 2015, with no collateral posted.

DISCLOSURE

Norton covenants to provide audited annual financial statements and quarterly disclosure to bondholders via the Municipal Securities Rulemaking Board's (MSRB) EMMA system. Quarterly disclosure consists of a management discussion and analysis, balance sheet, income statement, cash flow statement, and utilization statistics.