OREANDA-NEWS. March 10, 2015. Fitch Ratings has affirmed the 'AA-' rating on the following revenue bonds issued by the Hospital Finance Authority of the City of St. Joseph (MI) on behalf of Lakeland Hospitals at Niles and St. Joseph (Lakeland Hospitals):

--\\$29,600,000 variable-rate demand revenue, series 2002;
--\\$30,500,000 variable-rate demand revenue, series 2003;
--\\$42,200,000 variable-rate demand revenue, series 2006.

For all series listed above, liquidity is provided in the form of a standby bond purchase agreement (SBPA) with JPMorgan Chase Bank, N.A. Bonds are insured by Assured Guaranty Municipal Corp., whose financial strength is not rated by Fitch.

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of the obligated group.

KEY RATING DRIVERS

SOLID FINANCIAL PROFILE: The rating is supported by Lakeland Regional Health System's (LRHS) overall sound financial and operating profiles that generate metrics consistent with the 'AA-' rating.

LEADING MARKET POSITION: Continued financial stability reflects LRHS' position as the only hospital in its primary service area (PSA). Inpatient market share was a solid 69.4% in fiscal 2014. With limited regional competition, both independent and employed physicians are well aligned supporting steady patient flows. Further, Medicaid expansion resulted in significant volume growth in 2014, which is expected to remain elevated.

EXPOSURE TO GOVERNMENTAL PAYORS: Medicare and Medicaid as a percentage of gross revenues are high at 51.9% and 17% respectively, heightening susceptibility to federal and state budget cuts. Lakeland also has received considerable amount of supplemental funding in recent years but does not rely on the receipts to pay debt service or maintain positive operating profitability.

AGGRESSIVE CAPITAL STRUCTURE: The majority of LHRS' debt are variable rate demand bonds (VRDBs) supported by SBPAs expiring in November 2016. Concerns around potential put, remarketing, and renewal risk are mitigated by a solid liquidity position, with 409.2% cash to puttable debt at the fiscal year ended (FYE) Sept. 30, 2014.

RATING SENSITIVITIES

CONTINUED STABILITY EXPECTED: Fitch believes that despite its relatively small revenue base, LRHS' solid market position and physician platform provides a stable operating environment. Sustained balance sheet and debt service coverage metrics should support stability at the current rating. While not expected, unfavorable variance in utilization or supplemental funding levels may cause negative rating pressure.

CREDIT PROFILE

Lakeland Regional Health System is the parent organization to Lakeland Hospitals, which makes up the Obligated Group. Lakeland Hospitals consists of 250-bed Lakeland Hospital, St. Joseph (located in Benton Harbor/St. Joseph area) and 89-bed Lakeland Hospital (Niles, MI). In fiscal 2014 the obligated group represented 84% of assets and 74% of operating revenues of the system, which produced total revenues of \\$462.2 million. Fitch's analysis considers the credit profile of the system

Good Profitability

Profitability in fiscal 2013 and 2014 was sound, with operating margins of 4.5% and 3.7%, respectively. Sustained profitability levels were supported by solid financial results at Lakeland Hospitals (at or above 7% operating margin), which benefitted from increased volumes in 2014 due to Michigan's Medicaid expansion. Significant growth in outpatient volumes and hospital stays (inpatient plus observation cases) led to steady revenue growth and cash flow. Operating EBIDTA margins were similarly sound at 11.5% in 2013 and 10.4% in 2014, in line with the median of 11%.

Strong profitability continued through the three month interim period ended Dec. 31, 2014. Lakeland Hospitals produced operating and operating EBITDA margins of 14%, up from 2.5% and 10.7% the prior year. Management is budgeting a 5.8% operating margin for Lakeland Hospitals for fiscal 2015, which Fitch believes is reasonable.

One of Fitch's credit concerns relate to LRHS' high reliance on governmental payors with Medicare contributing 51.9% to gross patient revenues and Medicaid at 17%. LRHS also receives a substantial amount of supplemental funds (disproportionate share and provider fee), which has totaled \\$16-18 million annually for the last three years. While the hospital is vulnerable to budgetary cuts at the federal and state level, there is some room to withstand revenue pressure given its current level of profitability and cash flow.

Limited Competition

While Fitch is concerned about LRHS' relatively small revenue base and single market operations, the system's susceptibility to changes in the local economy is mitigated by the lack of direct competition in its service area. Additionally, there is limited physician competition in the area, which facilitates alignment with medical staff that does not depend on employment. Management reported that over 60% of area physicians are on LHRS' EPIC platform. Further, the system maintains strong relationships with other Michigan providers and collaborates on various clinical initiatives.

Strong Liquidity

Balance sheet continues to strengthen with good growth in liquidity and moderation of debt. Unrestricted cash and investments totaled \\$432.5 million at Sept. 30, 2014 equating to 377 days cash on hand, 44x cushion ratio, and 302.4% cash to debt, all stronger than the respective medians of 277 days, 26.5x, and 178.5%. Capital plans are modest and is expected to remain below annual depreciation levels. Continued balance sheet strengthening is expected.

DEBT PROFILE

At Sept. 30, 2014, the system had outstanding \\$143 million in long-term debt, of which 88% was variable rate and 12% was fixed rate. The obligated group debt consists of three VRDBs supported by JPMorgan chase SBPAs expiring in November 2016. The high amount of variable debt exposure is mitigated by LRHS' strong liquidity position, producing a cash to puttable debt ratio of 409.2%. Unrestricted liquidity includes funds specifically designated by the board to meet potential put needs (\\$107.5 million at FYE 2014). Debt service is mostly level, generating a MADS of \\$9.8 million (smoothed for relatively small bullet payments).

Debt metrics are solid, with a MADS coverage of 7.4x and 7x in fiscal 2014 and 2013, respectively, compared to the 'AA' median of 5.4x. Debt burden is low with MADS as a percentage of revenue of 2.1% and debt to capitalization of 18.8%, compared to the respective 'AA' medians of 2.6% and 31.1%. There are currently no new debt plans.

LRHS is counterparty to three fixed-rate payor swaps that closely follow the amortization structure of the outstanding bonds. As of Sept. 30, 2014, the mark to market on the swaps was negative \\$16.1 million. There is no threshold level for collateral posting at the current rating.

DISCLOSURE

Lakeland Hospitals discloses annual financial statements within 120 days and quarter unaudited financial statements within 45 days through the MSRB EMMA website.