OREANDA-NEWS. April 13, 2015. Fitch Ratings has affirmed the 'AA-' rating on the following revenue bonds:

--\\$105.63 million Indiana Finance Authority (Beacon Health System), series 2013A;
--\\$46.13 million Hospital Authority of St. Joseph County (Beacon Health System), series 2013C;
--\\$42.97 million Elkhart County Hospital Authority (Elkhart General Hospital), series 2008;
--\\$37.87 million Hospital Authority of St. Joseph County (Memorial Health System), series 2008A.

The Rating Outlook is Stable.

SECURITY

Debt payments are secured by a security interest in the pledged revenues of the Beacon Health obligated group, which includes Beacon Health System, Inc. (BHS), Memorial Hospital of South Bend, Inc. (MHSB), Beacon Medical Group, Inc. (BMG), Memorial Health Foundation, Inc. (MHF), Beacon Health Ventures, Inc. (BHV) and Elkhart General Hospital, Inc. (EGH). Pledged revenues include all cash receipts and accounts of the corporation.

KEY RATING DRIVERS

STRONG FINANCIAL PROFILE: Beacon's financial profile is characterized by strong profitability and liquidity, a low debt burden and robust debt service coverage.

SUCCESSFUL MERGER: Beacon Health System is the result of the merger between Memorial Health System and Elkhart General Hospital in December 2011. The affiliation has produced integration savings, solid market share in its primary service area and expanded clinical integration across the system, including a focus on post-acute care to provide for population health management.

GOOD MARKET SHARE POSITION: Beacon had a leading 58% market share in its primary service area in 2014 (January-June) with St. Joseph's Regional Medical Center, part of Trinity Health Credit Group (Trinity; rated 'AA', Stable Outlook) a distant second at 26%.

CAPITAL PROJECTS UNDERWAY: Beacon is currently undertaking several sizeable capital projects, including the Elkhart surgery replacement project and Memorial Children's expansion. These projects are being funded by a combination of bond proceeds, cash flow and philanthropy.

RATING SENSITIVITIES

CONTINUED IMPROVEMENT: Sustained profitability and further balance sheet strengthening, which would mitigate Beacon's single market focus, could lead to positive rating movement.

CREDIT PROFILE

Fitch believes the merger has improved the coordination of care and utilization of resources in a competitive market. With this merger, there is equal representation on the Beacon board of directors with seven board members from each hospital. MHSB is a 657-licensed (409-available) bed level 2 trauma center located in South Bend, IN approximately 15 miles west of Elkhart General Hospital, a 357-licensed (257-available) bed community hospital located in Elkhart, IN.

Beacon's total revenue in fiscal 2014 was \\$913.8 million (Dec. 31 year end).

GOOD PROFITABILITY
Beacon's fiscal 2014 and 2013 profitability was very strong, with operating margins of 6.1% and 6.2%, respectively. Operating EBITDA margin of 12.3% and 12.4% during the same time periods are also solid against Fitch's 'AA' category median of 11%. Sustained operating performance is attributed to Beacon's ability to leverage the benefits of the two-system merger by achieving savings in the areas of supply chain and labor, as well as increased technology and lean methodology efficiencies. Additionally, Beacon is expanding its geographic footprint in primary care and other ambulatory services and focusing on clinical integration and coordinated care, which Fitch believes will continue to drive strong operations.

Fitch notes that Beacon receives a significant amount of supplemental funding; including approximately \\$25 million in disproportionate share hospital (DSH) subsidy in fiscal 2014 and approximately \\$26 million budgeted for fiscal 2015. Furthermore, management is budgeting for a decline in the operating margin in fiscal 2015 to about 4.5%, reflecting a change to the hospital assessment fee (HAF) program, which is expected to negatively impact the system by about \\$17.6 million. However, Fitch views positively the recent announcement that the state of Indiana is expanding Medicaid eligibility in 2015 through creation of the Healthy Indiana Plan (HIP) 2.0, which will expand Medicaid and should benefit Beacon, but is not factored into the budget.

ROBUST LIQUIDITY
Strong cash flow generation in recent years has allowed Beacon to grow its unrestricted cash and investments position by 22%, from \\$632.2 million in fiscal 2012 to \\$773.5 million at fiscal 2014 year-end. Beacon's unrestricted cash and investments equated to 349.8 days cash on hand, 42x cushion ratio and 299.2% cash to debt at Dec. 31, 2014, all of which were favorable compared to the respective 'AA' category medians of 277.1 days, 26.5x and 178.5%.

CAPITAL SPENDING CONTINUES
Beacon is undertaking several large capital projects, which Fitch views favorably as they will better position the system for the changing healthcare environment. The EGH surgery replacement project will replace all surgical capacity including pre/post-surgical areas, as well as add a 44 bed inpatient unit, allowing the hospital to have all private rooms. The project is estimated to cost approximately \\$78 million (\\$43 million from series 2013 bond proceeds and about \\$35 million from cash flow) and was started in late 2013 and will be completed in the fourth quarter of 2015. The Memorial Children's expansion project will replace all inpatient and outpatient oncology children's services. The total project cost is estimated to be \\$46 million (funded from cash flow and philanthropy) and has been approved to start in 2015.

In addition to bricks and mortar investment, IT initiatives are a top capital priority. Management has standardized the IT platform across the two hospitals, as well as in home health, and is now converting all physician practices to Cerner. High capital spending is anticipated over the next few years and is budgeted at \\$142.8 million in fiscal 2015 and \\$104.9 million in fiscal 2016. Although Beacon has no current plans to issue additional debt, Fitch believes the system has some capacity at the rating level considering its strong historical cash flow and low debt burden.

SOLID MARKET SHARE
The service area is competitive, but as a combined entity, Beacon has a strong 58% market share in the primary service area in 2014 (January-June). Of this, Memorial Health System accounted for 35% of the market share, while Elkhart had a 23% share. St. Joseph Regional Medical Center (part of Trinity) is the closest competitor with 26%. In 2009, St. Joseph consolidated its two existing hospitals in the service area and opened a replacement hospital seven miles away from Memorial's campus.

St. Joseph County's economy remains challenged by a high unemployment rate at 7.3% as of January 2015 relative to state and national averages during the same time period of 6.7% and 5.7%, respectively. The challenged economy is reflected in Beacon's high exposure to Medicaid and self-pay payors, which accounted for 16% and 5% of gross revenues, respectively, in fiscal 2014.

DEBT PROFILE
Total debt is about \\$258.5 million, equating to light debt-to-capitalization of 19.3% relative to Fitch's 'AA' category median of 31.1%. Maximum annual debt service (MADS) coverage by EBITDA in fiscal 2014 was solid at 6.1x. Management has budgeted for debt service coverage to remain above 6x over the next three fiscal years, which Fitch believes is manageable given its strong cashflow.

DISCLOSURE
Beacon covenants to provide bondholders an annual audit within 150 days of fiscal year-end and quarterly disclosure within 60 days of quarter end for the first three fiscal quarters via the MSRB's EMMA system.