OREANDA-NEWS. Fitch Ratings has assigned an 'A+' rating to the approximately $109 million Colorado Health Facilities Authority hospital revenue bonds series 2016 issued on behalf of NCMC, Inc. (NCMC). In addition, Fitch has affirmed the 'A+' rating on NCMC's outstanding series 2003A&B bonds.

The series 2016 bonds will be fixed rate, and bond proceeds will be used to refund the series 2003A&B bonds and provide approximately $40 million of reimbursement for prior capital expenditures. The series 2016 bonds are expected to price the week of April 25.

The Rating Outlook is Stable.

SECURITY
The bonds are secured by a pledge of the gross receipts of NCMC. Debt service is funded primarily through contractual payments from Banner Health (Banner; revenue bonds rated 'AA-'/Stable Outlook), who operates the hospital under an operating agreement. Banner provides a limited guaranty on the bonds, which is limited to the amount of net contractual payments made under the operating agreement.

KEY RATING DRIVERS

OPERATING AGREEMENT WITH BANNER HEALTH: North Colorado Medical Center (the medical center) is a county owned hospital that is subleased to NCMC. In turn, NCMC contracts with Banner to operate the hospital. Banner makes contractual payments to NCMC monthly for the use of the facility, and net income is routinely transferred to Banner's holding company subject to reconciliation at certain periods. Fitch views the relationship with Banner favorably as operating performance of the medical center has been very strong and Banner has been operating the facility since 1995. However, the operating agreement terminates in 2027, before the final maturity of the bonds in 2033.

STRONG PROFITABILITY: Fitch's analysis is based on the combined entity (NCMC and the medical center). Operating performance was very strong the last two years with operating margins of 9.1% in 2015 (Dec. 31 fiscal year end) and 8.7% in 2014. Strong profitability has been driven by physician alignment initiatives, focus on expense reductions, and improved payor mix.

MAJOR INVESTMENT IN PLANT: NCMC invested in a $60 million master campus plan infrastructure project beginning in 2014 that addressed deferred maintenance needs at the hospital and the remaining spend ($12 million) is expected in 2016. Ongoing capital expenditures are projected at $16 million, which is less than 1x depreciation expense.

HIGH DEBT BURDEN: Debt burden has always been high but maximum annual debt service (MADS) declines slightly with the series 2016 issuance despite the additional debt due to the slight extension on the final maturity of the bonds. MADS accounted for 4.2% of total revenue in 2015 compared to the A category median of 2.8%. MADS coverage is solid due to strong profitability with 4.3x in 2015 and 4.7x in 2014 compared to the A category of 4.2x.

GOOD BALANCE SHEET: The combined entity had unrestricted cash and investments of $261.4 million. Liquidity metrics declined in 2015 due to high capital spending and weak investment performance. Days cash on hand and cash to debt were 252 and 137.4%, respectively at Dec. 31, 2015. With the expected reimbursement of prior capital expenditures, pro forma days cash on hand and cash to debt would be 290.6 and 136.6%, respectively.

COMPETITIVE MARKET: The medical center is located about 60 miles north of Denver and faces strong competition from University of Colorado Health (rated 'AA-'), which has moved further into the medical center's service area as the two community hospitals (Poudre Valley and Medical Center of the Rockies) in the medical center's service area joined University of Colorado Health in 2014.

RATING SENSITIVITIES

SUSTAINED PERFORMANCE: Fitch expects NCMC and the medical center's financial performance to remain stable with improved liquidity levels due to the reimbursement of prior capital expenditures.

CHANGES TO OPERATING AGREEMENT: Any material changes to the operating agreement between NCMC and Banner Health could have an impact on the rating and will be assessed when/if they occur.

CREDIT PROFILE
The North Colorado Medical Center (a 378 licensed bed hospital in Greeley, Colorado) and outpatient clinics are owned or leased by NCMC and operated by Banner. Fitch's analysis is on the combined entity, which includes NCMC (has unrestricted cash and investments, little income statement activity and North Colorado Medical Center and Banner Medical Clinics - Weld County (majority of operations). The combined entity had $440.8 million in total revenue in 2015.

RELATIONSHIP WITH BANNER HEALTH
NCMC has had a contractual relationship with Banner Health since 1995. The most recent operating agreement was executed in Jan. 1, 2012 and terminates in 2027. Under the agreement, Banner makes contractual payments totaling approximately $30 million annually. Banner has full operational responsibility to operate the hospital under the agreement. The hospital is operated as part of Banner's western region. The relationship with Banner gives NCMC access to the effective business practices and strong operational support of a successful regional system. Overall, Fitch views NCMC's relationship with Banner as a key credit strength.

Banner retains the net income of the facility and there is an income reconciliation in 2017, 2022 and 2027. The income reconciliation includes the sharing of operating margins above 5% for the prior five year period or sharing of loss if operating performance was below 0% for the prior five year period. It is expected that Banner will owe NCMC in 2018 for the income reconciliation period ended 2017 and plans to advance NCMC $10 million over the next two years as a partial payment of the amount owed.

STRONG PROFITABILITY TEMPERED BY HIGH DEBT BURDEN
The combined entity's profitability has been very strong the last two years and is projected to be around the same level in 2016. Although inpatient volume has declined, outpatient volume has increased. Management is focused on expense reductions including a profitable Medicare cost profile and reducing administrative and overhead expenses. Operating margins were very strong at 9.1% in 2015 and 8.7% in 2014 and much higher than the prior periods with 4.2% in 2013 and 4.7% in 2012. The combined entity also benefited from an increase in provider tax proceeds, which netted $23.6 million in 2015 and $17.7 million in 2014 compared to $15.9 million in 2013 and $11 million in 2012.

COMPETITIVE MARKET
The medical center maintains a leading market share in its primary service area of Weld County (accounted for an estimated 81.9% of admissions in 2015). The hospital provides a comprehensive range of services and is the regional referral center for burn victims and is designated as a Level II trauma center. However, market share has declined in the primary service area, but management believes its outpatient presence/share remains stable. Market share in the primary service area declined to 54.3% through the third quarter 2015 from 62.4% in 2013. There is strong competition from the University of Colorado Health system, with facilities that are less than 30 miles away. There are several initiatives underway with Banner and its other facilities in the region including narrow network contracts to maintain the hospital's market position.

DEBT PROFILE
Total pro forma debt after the series 2016 issuance will be $220.6 million with 71% underlying fixed rate and 29% underlying variable rate. The other debt outstanding is direct bank placement, which do not have renewal risk or additional covenants. The direct bank placement debt includes $64.4 million series 2013 with Compass Bank (indexed floating) and $47 million series 2012 with Compass Bank (fixed rate) that both have a final maturity in 2027.

Including its swaps, the debt profile is 100% fixed rate. There are collateral posting thresholds (above $10 million), and although these thresholds have been reached historically, management stated that collateral has never been required to be posted by the counterparty.

Pro forma MADS reduces to $18.5 million from $19.3 million and the final maturity of the debt will be 2033 from 2030.