Fitch Maintains Anthem's Ratings on Negative Watch
Today's rating action follows the completion of a periodic review of ANTM's ratings. Fitch had previously placed ANTM's ratings on Rating Watch Negative on July 24, 2015 following the company's announcement that it had entered into an agreement under which it will acquire Cigna Corp. (CI). Excluding the ratings-negative aspects of that planned acquisition, Fitch believes that today's review would have resulted in the affirmation of ANTM's ratings with a Stable Outlook.
The Negative Watch status reflects the negative effect the planned acquisition will have on ANTM's financial leverage metrics and potential earnings disruptions that could arise in the short-term subsequent to the acquisition's close as ANTM integrates CI from an operational and management perspective. Fitch plans to resolve the Rating Watch before ANTM accesses the debt markets to partially fund the acquisition. If the acquisition proceeds along the terms announced in the merger agreement, Fitch expects to downgrade ANTM's ratings by one notch or to affirm them, most likely with a Negative Outlook.
Fitch's assumption is that ANTM may have to agree to divest operations in various markets in order to obtain necessary regulatory approvals, but that the impact of such divestitures will not be meaningful relative to ANTM's and CI's recent financial results. Fitch's expectation is that the merger will close in the second half of 2016 (2H16).
Post-close Fitch anticipates using its group rating methodology to assess ANTM's and CI's ratings and believes that CI's ratings and those of its insurance subsidiaries will converge with ANTM's and its insurance subsidiaries' ratings. Fitch also expects its view of ANTM's post-acquisition consolidated financial profile to incorporate its views of CI's financial profile.
'Scores' assigned to rating factors underlying ANTM's ratings, the scores' relative influence on the ratings, and the forward trends associated with each of the rating factors are discussed below under key rating drivers. Collectively these scores support ANTM's ratings and their Negative Rating Watch status.
KEY RATING DRIVERS
Capitalization and Leverage: Scored 'bbb+': 'higher' influence on ratings, negative forward trend. Key considerations underlying the score are ANTM's high debt-to-EBITDA and financial leverage ratios and solid insurance company NAIC risk-based capital (RBC) ratios. The negative forward trend reflects Fitch's expectation that ANTM will issue approximately $22 billion of new debt to fund a portion of the CI acquisition; a large increase in comparison to the company's $16.6 billion of outstanding debt at June 30, 2015. Fitch estimates that ANTM's post-acquisition debt-to-EBITDA ratio and financial leverage ratio will approximate 3.8x and 48%, respectively, at year-end 2016, and that depending on earnings levels, share repurchases, and debt reduction, these ratios will migrate downward to 2.5x-3.0x and 38%-42% in the 24 months following the acquisition's close. At June 30, 2015, ANTM's debt-to-EBITDA and financial leverage were 2.4x and 42%, respectively. Fitch also expects that post-acquisition, ANTM's and CI's insurance company subsidiaries will be managed to RBC ratios of approximately 225%-250% (company-action-level basis), meaningfully lower than the companies' reported ratios in recent years. Fitch calculates ANTM's year-end 2014 organization-wide NAIC RBC ratio at 258%.
Debt Service Capabilities & Financial Flexibility: Scored 'a+': 'higher' influence on ratings, negative forward trend. Fitch projects ANTM's post-acquisition operating EBITDA-based interest coverage ratios at 6x-9x; a potentially meaningful decline compared with ANTM's operating EBITDA-based interest coverage ratio that averaged 10x from 2012 through 1H15. Fitch also believes that ANTM's post-acquisition financial flexibility will be constrained due to the approximate $22 billion of debt, $6 billion of cash and $21 billion of equity that ANTM is expected to issue to fund the acquisition of CI. In recent years, the company maintained strong financial flexibility with significant access to the debt markets, substantial cash and invested holding company assets that totaled $2.2 billion at June 30, 2015, and an untapped $2 billion bank credit facility.
Market Position Size/Scale: Scored 'aa-': 'moderate' influence on ratings, positive forward trend. Key considerations underlying the score are the company's very large and diverse membership base, leading market shares in 14 states where it holds Blue Cross and or Blue Shield (BCBS) licenses, and significant economies of scale. The positive forward trend reflects anticipated market position and size/scale benefits the CI acquisition would bring to the ANTM organization. In particular, Fitch believes that CI's strong position in the market for self-insured mid-sized and large employer groups in the U.S., and in international markets, including U.S. expatriates, will benefit the ANTM organization's market position. ANTM's membership at June 30, 2015 totaled 38.5 million, making the company the second largest health insurer in the U.S. The company's membership consists primarily of employer group members but also includes meaningful Medicaid, primarily through its Amerigroup subsidiaries, and individual and Medicare membership. ANTM's membership is geographically diversified throughout the U.S. with large portions derived from California, Ohio, Virginia, Indiana, Georgia, Kentucky and New York where it holds leading market shares.
Financial Performance and Earnings: Scored 'a': 'moderate' influence on ratings, positive forward trend. Fitch believes that ANTM generates solid and consistent financial performance and earnings that are underpinned by the company's large market share in key markets and significant size and scale benefits. From 2012 through 1H15 ANTM generated average EBITDA-to-revenue margins and annualized net income-to-average capital ratios of 8.6% and 7.4%, respectively. From 2012 through 2014, ANTM generated average annual EBITDA of $5.4 billion. The positive forward trend reflects Fitch's belief that over the longer term, ANTM's post-acquisition EBITDA-to-revenue margins will improve in comparison to the company's historical margins as it benefits from CI's comparatively higher EBITDA-to-revenue margins. Additionally, ANTM has disclosed that it expects to achieve $2 billion of synergy-related expense savings within two years of the acquisition's close. Fitch estimates that the combination of these two factors could add 150-180 basis points to ANTM's run-rate ratio of EBITDA-to-revenues.
Group Rating Approach: ANTM's insurance company subsidiaries' ratings reflect Fitch's application of a group rating approach. Fitch considers ANTM's rated insurance company subsidiaries to be 'core' ANTM subsidiaries based on their contribution to the group's overall premium and capital bases, shared resources and common management. Fitch's ratings on ANTM's operating subsidiaries reflect the agency's belief that AMTM and its affiliates have the willingness, due in part to the value of the subsidiaries' BCBS brands to ANTM, and the ability to support one another. Additionally, the IFS ratings of several ANTM subsidiaries benefit from a parent-company guaranty.
RATING SENSITIVITIES
Fitch believes that ANTM's ratings are most sensitive to the company's ability to reduce its post-acquisition financial leverage metrics. If Fitch concludes that ANTM's sustained debt-to-EBITDA and financial leverage ratios are unlikely to approximate 3.0x and 40% or lower, respectively, within 24 months after the close of the planned CI acquisition, then it will likely downgrade ANTM's ratings by one notch. Other factors that could contribute to a downgrade are earnings disruptions that arise as ANTM integrates CI and lead Fitch to question its assumption that the combination of CI's higher EBITDA-based margins and planned post-acquisition-related expense synergies will result in higher post-acquisition margins for ANTM. Additionally, downgrades could result if in order to gain regulatory approval for the merger, ANTM has to divest operations that are more meaningful from a financial perspective than that currently envisioned by Fitch, or if ANTM's compliance with Blue Cross and Blue Shield Association licensing agreements proves to be more constraining from a financial perspective than Fitch currently foresees. Finally, Fitch believes that ANTM's ratings could be downgraded if the ANTM-CI merger fails to close and other recently announced merger agreements between competitors do close.
Fitch maintains its Negative Watch on the following ratings:
Anthem, Inc.
--Long-term Issuer Default Rating (IDR) 'BBB+';
--Short-term IDR 'F2';
--$2.5 billion commercial paper program 'F2'.
The 'BBB' rating assigned to the following:
--1.250% senior notes due 9/10/2015;
--2.375% senior notes due 2/15/2017;
--5.875% senior notes due 6/15/2017;
--1.875% senior notes due 1/15/2018;
--2.300% senior notes due 7/15/2018;
--7.000% senior notes due 2/15/2019;
--2.250% senior notes due 8/15/2019:
--4.350% senior notes due 8/15/2020;
--3.700% senior notes due 8/15/2021;
--3.125% senior notes due 5/15/2022;
--3.300% senior notes due 1/15/2023;
--3.500% senior notes due 8/15/2024;
--5.950% senior notes due 12/15/2034;
--5.850% senior notes due 1/15/2036;
--6.375% senior notes due 6/15/2037;
--5.800% senior notes due 8/15/2040;
--4.625% senior notes due 5/15/2042;
--2.750% senior convertible debentures due 10/15/2042;
--4.650% senior notes due 1/15/2043;
--4.65% senior notes due 8/15/2044;
--5.100% senior notes due 1/15/2044;
--4.850% senior notes due 8/15/2054.
The 'BBB-' rating assigned to:
--1.900% subordinated notes due 5/1/2028.
Anthem Holding Corp.
--Long-term IDR 'BBB+'.
Anthem Insurance Companies, Inc.
--Long-term IDR 'A';
--9.000% surplus notes due 4/1/2027 'A-';
--IFS 'A+'.
The 'A+' IFS ratings of the following ANTM subsidiaries:
Anthem Blue Cross Life & Health Insurance Company
Anthem Health Plans, Inc.
Anthem Health Plans of Kentucky, Inc.
Anthem Health Plans of Maine, Inc.
Anthem Health Plans of New Hampshire, Inc.
Anthem Health Plans of Virginia, Inc.
Blue Cross of California
Blue Cross and Blue Shield of Georgia, Inc.
Blue Cross Blue Shield Healthcare Plan of Georgia, Inc.
Community Insurance Company, Inc.
Empire HealthChoice HMO, Inc.
Empire HealthChoice Assurance, Inc.
HealthKeepers, Inc.
Healthy Alliance Life Insurance Company
HMO Missouri, Inc.
Matthew Thornton Health Plan, Inc.
Rocky Mountain Hospital & Medical Service, Inc.
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