OREANDA-NEWS. Fitch Ratings has affirmed the rating on MultiCare Health System's (MultiCare) $888.6 million of rated debt issued through the Washington Health Care Facilities Authority at 'AA-'. Total outstanding debt was $993.7 million as of Dec. 31, 2015.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a gross receivables pledge of the obligated group (OG). The OG comprised 97% of total assets and 99% of total revenue of the consolidated entity in fiscal 2015 (Dec. 31 year end; audited). Fitch's analysis is based on the consolidated entity.

KEY RATING DRIVERS

CONTINUED STRONG FINANCIAL PERFORMANCE: MultiCare's overall financial profile is solid for its rating level with strong profitability and good liquidity. Profitability has been strong due to a continued focus on expense management and robust cash flow has resulted in very good debt service coverage.

INTEGRATED DELIVERY NETWORK: MultiCare is a regional provider with five hospitals and an extensive outpatient and physician network that is connected through a mature electronic health record (EHR; Epic) that was implemented in 1998. This platform is being leveraged to enhance access and improve quality outcomes. MultiCare recently announced its plans to develop a new line of urgent care facilities called Indigo, which is retail focused and aimed to provide the consumer a convenient and upscale experience.

EVOLVING TO POPULATION BASED CARE: MultiCare is in its second year of operations of MultiCare Connected Care, a clinically integrated network that is able to coordinate care with independent providers and offer narrow network products. The number of lives under value based agreements has increased to 70,000 from 60,000 during Fitch's last review in April 2015. This includes the direct contract with Boeing, which is an accountable care organization agreement that includes other providers in the narrow network (University of Washington).

COMPETITIVE MARKET: MultiCare has a strong presence in its primary service area of Pierce County and recent growth has been concentrated in its secondary service area, South King County. Market share has remained stable however, the area is highly competitive. In Pierce County, MultiCare had 46.8% market share compared to its main competitor, Franciscan Health System (part of Catholic Health Initiatives, rated 'A+'/Outlook Negative by Fitch), with 41.2% market share. MultiCare continues to pursue growth strategies and expand access.

STRONG CAPITAL REINVESTMENT: The current five-year capital plan is robust at $1.2 billion for fiscal 2016 - 2020 and includes several major projects. Major investments include a new hospital in Covington, expansion at Auburn Medical Center, a free standing psychiatric hospital in partnership with Franciscan, and its retail growth strategy (Indigo and retail clinics in partnership with RiteAid). Currently, there are no additional debt plans, and MultiCare has approximately $88 million of project funds available from the series 2015A issuance.

MODERATING DEBT BURDEN: Total debt outstanding is $968.6 million with 76% underlying fixed rate and 24% underlying variable rate. MultiCare's debt burden has been moderating and MADS accounted for 2.9% of total revenue in fiscal 2015 compared to 3.7% in fiscal 2012 and the 'AA' category of 2.4%. Cash to debt is one of the few metrics that compares unfavorably to the 'AA' category medians with 163.9% at March 31, 2016 compared to the 'AA' category median of 201.7%.

RATING SENSITIVITIES

CURRENT PERFORMANCE PROVIDES FLEXIBILITY: Fitch believes MultiCare's financial profile provides the organization with the financial flexibility to implement the necessary initiatives to achieve its strategic priorities. Upward rating movement is possible if MultiCare improves its cash to debt metric closer to the 'AA' category median and sustains other metrics in excess of the 'AA' category medians to offset risks with its smaller revenue size compared to other rated peers and location in a competitive market.

Credit Profile

MultiCare is an integrated regional system based in Tacoma, WA with four adult hospitals and one pediatric hospital (1,130 licensed beds), various outpatient and physician clinics throughout its service area in South Puget Sound, as well as home health/hospice and behavioral health services. Total revenue in fiscal 2015 was $1.9 billion.

Transition to Value Based Reimbursement

MultiCare is participating in value based contracts that have been in place for two years and total covered lives are approximately 70,000. These value based contracts are through MultiCare Connected Care, a clinically integrated network that has over 2,000 providers, which include MultiCare's employed physicians, MultiCare Medical Associates, as well as independent physicians. The value based contracts typically have a medical cost target or quality improvement targets. These contracts currently represent a small percentage of MultiCare's overall revenue.

Sustained Strong Profitability

MultiCare's profitability has been consistently strong for its rating level. Operating margin in fiscal 2015 was 11.5% and exceeded budget. This compared to 10.6% in fiscal 2014 and 9.1% in fiscal 2013. In 2015, MultiCare did receive a higher amount related to the safety net assessment program ($19 million related to prior year period) due to the timing of the approval of various portions of the program. A normalized annual amount is around $14 million. Even without the $19 million, MultiCare's profitability was still very strong. Profitability metrics reflect the reclassification of the cash settlement on swaps to interest expense from non-operating expense in the audited statements.

Management implemented cost reduction initiatives of $100 million a year in 2015, 2016 and 2017 as the organization has historically been a high cost provider. The areas of focus include corporate and shared services and productivity improvements. MultiCare has budgeted an operating margin of 8.5% for 2016. Through the three months ended March 31, 2016, operating margin was 7.2% compared to 8.5% in the same prior year period.

Good Liquidity

Total unrestricted cash and investments were $1.7 billion as of March 31, 2016, which has increased from $1.1 million at fiscal year-end 2012 despite healthy capital spending. MultiCare had 365.9 days cash on hand at March 31, 2016 compared the 'AA' category median of 289.4 while cash to debt compares unfavorably at 163.9% to the 'AA' category median of 201.7%. Fitch expects continued liquidity growth as operating cash flow is in excess of projected capital spending.

Capital Plan

The capital plan for 2016 - 2020 totals $1.225 billion and the majority of the spending is related to expanding its market presence and access. Major projects include the construction of a hospital in Covington with 48 inpatient beds. The hospital is expected to open in the fourth quarter of 2017 and the cost of this project is approximately $85 million. The Auburn Medical Center project is expected to total $100 million and includes a new emergency department and a new 68 bed tower that should open in late 2018. Other capital spending is mainly in the ambulatory setting.

Moderating Debt Burden

Total debt as of Dec. 31, 2015 was $993.686 million and the debt profile is conservative with 76% underlying fixed rate and 24% underlying variable rate. MultiCare's only uncommitted capital includes $149 million series 2007C and D variable rate demand bonds with a letter of credit from Barclays that expires April 4, 2017 and Oct. 3, 2017, respectively and a $80 million series 2012B direct bank loan (non rated) with Wells Fargo that is at an indexed floating rate and has an initial term to Oct. 1, 2019.

MultiCare has two basis swaps and three fixed payer swaps outstanding and the mark to market valuation totaled negative $57.7 million at Dec. 31, 2015. There is no collateral posting requirements on the fixed payer swaps. The basis swaps require collateral posting at a threshold of $15 million, and the mark to market valuation of the basis swaps at Dec. 31, 2015 was positive $1.2 million.

MultiCare's debt burden has been moderating over time, and given the strong profitability debt service coverage has been consistently strong. Aggregate debt service is level and MADS is $57.3 million. Debt service coverage was 7.4x in fiscal 2015, 7.1x in fiscal 2014 and 6x in fiscal 2013 compared to the 'AA' category median of 5.7x.

Disclosure

MultiCare covenants to provide annual and quarterly financial information to the MSRB's EMMA system.